Published October 9, 2008

Shock rate cuts to jolt markets back to life

Fed and other central banks join hands in unprecedented move to fight crisis

By ANDREW MARKS
NEW YORK CORRESPONDENT
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AS Europe bled and Asian markets licked their wounds, several central banks across the world, led by the US Federal Reserve, announced a coordinated interest rate cut in an effort to stem the global financial crisis.

Face of the market: A broker in London responding to yesterday's news, including the Bank of England rate cut

This is the latest of what has become an increasingly urgent series of measures to cure investors of the rampant fear of a worldwide systemic collapse of the financial markets.

The half percentage point global rate cut also represented the first time in the growing crisis in which several central banks, representing governments from around the world, have acted in unison to overcome frozen credit markets, combat swooning economies and prevent further bank failures.

The Fed cut its key lending rate to 1.5 per cent, the European Central Bank cut its rate to 3.75 per cent and the Bank of England to 4.5 per cent - each with a half-point slash. The central banks of Canada, Sweden and Switzerland also reduced rates, while the Bank of Japan expressed its strong support of these policy actions, the Fed said in a statement released in the midst of another dramatic decline in Asian and European markets before the US stock market began its trading day yesterday.

The coordinated policy action initially produced a turnaround in global stock markets, paring losses, which in some cases were approaching the 10 per cent level. But the gloom would not go away so easily. In London, for example, the FTSE swung wildly from a 6 per cent decline to move into positive territory before slipping back again, to close at 4,366.69 down 238.53 points or 5.18 per cent.

Wall Street reacted cautiously to the overnight moves at the opening bell yesterday morning. The Dow Jones Industrials, which ended on Tuesday with a late plunge that produced the blue-chip index's fourth decline of more than 5 per cent in just two weeks' time, climbed more than 100 points in the first few minutes of trading, reaching a 1.9 per cent advance before resuming its fall to 9,256.99 points by midday in New York on investor fears that the rate cuts would fail to unfreeze the credit markets and avert a global recession.

US investors' enthusiasm was being tempered by the latest sobering economic data released yesterday morning, signalling the rising likelihood that the financial market turmoil will make the US recession a more prolonged and severe one than economists were projecting just three weeks ago. Initial results from US retailers showed a dramatic slowdown in September sales, indicating that the upcoming holiday shopping season will be a gloomy one.

'I don't know that a rate cut in and of itself is going to do all that much to reverse the economic decline or stem the fear in the markets, but the fact that the Fed and all these other central banks are acting in concert to cut rates should reassure investors that at least the governments of the world's major economies are finally taking this crisis seriously enough to work together to prevent the chaos from further enveloping the global economy,' said Sam Stovall, chief investment strategist at Standard & Poor's. 'The psychological impact of these rate cuts, along with Britain's announcement of a massive bailout of its banks worth hundreds of billions of dollars, should at least calm the extreme levels of panic that we've witnessed the last couple of days.'

In England, Prime Minister Gordon Brown proclaimed 'the global financial market has ceased to function', in explaining the need for his country's rescue plan, which will amount to a minimum of US$350 billion.

The Fed had been resisting enacting further rate cuts since April, despite sagging equities and credit markets, but pressure for further monetary policy easing had been growing by the day. And in a speech on Tuesday, Fed chairman Ben Bernanke hinted that he was inclined to reduce the fed funds rate, the rate at which banks lend one another money, given the severe threat to the flagging US economy that the market chaos has entailed.

In its statement, the Fed, which also approved a 50 basis-point decrease in the discount rate to 1.75 per cent, said it reduced rates 'in light of evidence pointing to a weakening of economic activity and a reduction in inflationary pressures', adding that 'incoming economic data suggest that the pace of economic activity has slowed markedly in recent months'.

'Moreover, the intensification of financial market turmoil is likely to exert additional restraint on spending, partly by further reducing the ability of households and businesses to obtain credit. Inflation has been high, but the committee believes that the decline in energy and other commodity prices and the weaker prospects for economic activity have reduced the upside risks to inflation,' the Fed's statement read.