On September 18, the U.S. Federal Reserve (Fed) reduced, for the first time in the past four years, the federal funds rate by 50 basis points, down to 4.75 percent. A month later, the Fed reduced the interest rate again by 25 basis points to 4.5 percent.

The two interest rate reductions in a period of less than two months proved the damage of the sub-prime crisis to the U.S. economy is greater than expected. Judging from the Fed's moves, the economic slowdown led by the shrinking housing market is their major worry.

"From the positive view, if the Fed's interest reduction can help alleviate the slowdown and promote economic development in the United States, it will benefit China's external demand," said Fred Hu, Managing Director of Goldman Sachs Asia. In Hu's opinion, the Fed's interest rate reduction is obvious helpful to stabilizing market and investor confidence.

However, Hu said that the U.S. economy is now in a very vulnerable and unstable stage. If the situation was not improved soon, U.S. economic growth would be much lower than the potential growth rate of 2.5-3 percent, and recession might rear its ugly head.

Heavier pressure on renminbi appreciation is the most direct impact of the interest reduction in the United States. According to Hu, the sub-prime crisis has led the United States into an interest reduction cycle, while the inflation pressure has led China into an interest raising cycle. Driven by both factors, the U.S. dollar is more likely to further depreciate. The reduction by the Fed has shortened the interest difference between the two countries, intensifying pressure for renminbi appreciation.

"It may cause too much hot money to swarm into China, aggravating the excess liquidity in China," Hu said. "Further expansion of liquidity will also cause the further accumulation of an asset bubble in China."

Yi Xianrong, a Chinese economist, said the two reductions in the United States and several interest rate rises in China will make the Chinese capital market more alluring. Inflow of more capital will further increase China's foreign exchange reserve, and curbing inflation will be a more arduous task for China's central bank. At the same time, pressure on the renminbi to appreciate will intensify.

Yi pointed out that the Fed reduction will have a huge impact on the Chinese economy. While China is continuously raising the interest rate, the Fed's reduction will limit the space of that rise. Together with surging prices and higher asset prices in the domestic market, monetary policies will have little room to maneuver in China.

Another potential impact is that the abnormal fluctuations of U.S. dollar, gold and oil prices brought about by the Fed's moves may not only fail to stimulate U.S. economy, but also create more turmoil for the U.S. and global economy.

"If the U.S. economy really slows down or even recedes, its impact on China may be heavier than on the U.S. economy," Yi said.

In his opinion, interest rate reduction can further push up assets prices and stimulate inflation. Thus, the problem will not only be dollar depression and inflation driven by imports, but that the confidence of dollar-nominated debts holders could be shaken, leading to an underselling of U.S. treasury bonds. Because the Chinese Government holds a large number of U.S. treasury bonds, the potential risks will be higher.

However, the Chinese Government, unlike economists, hasn't shown much worry about the Fed's recent moves.

Zhou Xiaochuan, Governor of the People's Bank of China (PBC), the country's central bank, pointed out on September 18 when the Fed made the first interest reduction that the PBC didn't feel pressure from changes in interest difference between China and the United States. This is because China's central bank pays more attention to changes in economic activities such as domestic consumption and investment, and decides its monetary policies based on these changes. In other words, even though the Fed reduced the interest rate, because of the rapid increase of the consumer price index in the domestic market, to curb the overheated domestic economy and inflation is still the primary goal of the government's monetary policies.

It's not difficult to judge from the actions of the PBC that the central bank's monetary policies pay close attention to changes of monetary policies of the Fed, but still set the goals of its monetary policies based on changes of domestic economy and investment. That is to say, although the Fed's moves do influence the Chinese economy, these effects are not yet enough to change the course of China's monetary policies.