The US Federal Reserve is now very likely to cut its key interest rate by 0.5% in an effort to show US financial markets it is alert to the spreading loss of confidence. Size matters in these things, and in less than 24 hours we will see the difference a half a per cent cut can make to spirits in financial markets around the world. 

And not before time. The subprime mess and its associated credit market freeze is moving beyond being a problem merely for the banks and their high paid bankers. For three of the last four days in Britain we have seen panic as thousands of people queue to withdraw money from Northern Rock. Faith in banks has been rapidly eroded and for no apparent reason.

The rescue of Northern Rock was supposed to reassure markets and depositors that the bank was in good hands and there would be enough money for everyone to be paid: instead tens of thousands of ordinary Britons have taken their money out. Perversely they are putting it in other banks, so their faith in the banking system has been unaffected. But the UK Government and authorities are so scared of the situation worsening, that the Government now says it will guarantee all deposit in banks hit by the crisis (presumably that means they will be bailed out by the Bank of England).

It’s an attempt, with an open-ended guarantee, to stop the run at Northern Rock spreading and infecting depositors at other banks whose shares have been sold off as concerns grow.

It’s all but pressure on the Fed. Instead of the Fed cutting its rate by 0.25% to take pressure off the wider economy and markets, the weights are now on it to cut by 0.5% to reassure markets and everyone associated with it that it’s on top of the situation. The queues in London and impending financial reports from four of the five major investment banks on Wall Street this week, make it imperative that the Fed does something to send a signal that it sees the problems and is tackling them.

Contrary to a belief that the Fed’s cut will be all about lessening the dangers to the US economy, it will be more about easing the pressure on financial markets, especially after the Northern Rock bailout and the continuing weakness in European and US banking stocks.