Fed, ECB, Central Banks Cut Rates in Coordinated Move

A security officer stands outside of the Federal Reserve building in Washington on Sept. 16, 2008. Photographer: Jay Mallin/Bloomberg News

Oct. 8 (Bloomberg) — The Federal Reserve, European Central Bank and four other central banks lowered interest rates in an unprecedented coordinated effort to ease the economic effects of the worst financial crisis since the Great Depression.

The Fed, ECB, Bank of England, Bank of Canada and Sweden’s Riksbank each cut their benchmark rates by half a percentage point. The Bank of Japan, which didn’t participate in the move, said it supported the action. Switzerland also took part. Separately, China’s central bank lowered its key one-year lending rate by 0.27 percentage point.

Today’s decision follows a global meltdown that sent U.S. stock indexes heading for their biggest annual decline since 1937; Japan’s benchmark today had the worst drop in two decades. Policy makers are also aiming to unfreeze credit markets after the premium on the three-month London interbank offered rate over the Fed’s main rate doubled in two weeks to a record.

“They are throwing the kitchen sink in to try to find stability,” said Gregory Miller, chief economist at SunTrust Banks Inc. in Atlanta. “They are clearly trying to get the transmission started again” after a freeze-up of money markets.

The Fed reduced its benchmark rate to 1.5 percent. The ECB’s main rate is now 3.75 percent; Canada’s fell to 2.5 percent; the U.K.’s rate dropped to 4.5 percent; and Sweden’s rate declined to 4.25 percent. China cut interest rates for the second time in three weeks, reducing the main rate to 6.93 percent.

Official Statement

“The recent intensification of the financial crisis has augmented the downside risks to growth and thus has diminished further the upside risks to price stability,” according to a joint statement by the central banks. “Some easing of global monetary conditions is therefore warranted.”

After an initial rally, European shares and U.S. stock indexes headed lower. Some analysts said the central banks should have lowered rates by more, and predicted further reductions. Economists at Goldman Sachs Group Inc. and Morgan Stanley now project another half-point move by the Fed at its Oct. 28-29 meeting.

Futures on the Standard & Poor’s 500 Stock Index dropped 3.7 percent at 9:19 a.m. in New York, after plummeting 15 percent in the past five trading days. Europe’s Dow Jones Stoxx 600 Index slumped 3.9 percent. Japan’s Nikkei 225 Stock Average lost 9.4 percent to 9,203.32 earlier today, before the announcement.

“It should have been 1 percent to have a real impact,” said Robert Leonardi, a senior lecturer on European Union politics at the London School of Economics.

World Recession

Global policy makers are reducing rates as economies weaken around the world. The International Monetary Fund said the global economy is heading for a recession in 2009 and increased its estimate of losses from the financial crisis to $1.4 trillion.

The Fed’s Open Market Committee, which voted unanimously for the move, said in its statement 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.”

European policy makers were forced into action after the collapse of Lehman Brothers Holdings Inc. last month roiled world financial markets and caught them off guard. The ECB raised rates in July and Bank of England Governor Mervyn King warned the government as recently as Sept. 16 that inflation was set to accelerate.

The decision to let Lehman go “had enormous, very unfortunate consequences,” Trichet said Oct. 2. On the same day, he said the ECB was ready to cut rates.

Bernanke Message

Today’s action comes a day after Fed Chairman Ben S. Bernanke failed to assuage investors’ concerns about the deteriorating economy by signaling he was ready to lower borrowing costs.

Fed officials, who have kept their benchmark rate at 2 percent since April, may have wanted time for their record loans to the financial industry and new programs, including purchases of commercial paper, to bear fruit before lowering rates. Investors instead perceive the economic outlook deteriorating more rapidly, necessitating rate reductions.

The declines in U.S. shares the past two days followed pre- market opening announcements of fresh actions by the Fed to unblock credit markets. On Oct. 6, the U.S. central bank doubled its planned auctions of cash to banks to as much as $900 billion. Yesterday, it unveiled a unit to buy commercial paper, debt used by companies for short-term funding.

G-7 Meeting

Central bankers acted two days before they gather with finance ministers from the Group of Seven industrial nations in Washington. The timing suggests the central banks sought to avoid any appearance of being influenced by governments, said Ted Truman, former chief of the Fed’s international-finance division.

“It was clear that if they wanted to do it, they had to do it before Friday,” said Truman, now a senior fellow at the Peterson Institute for International Economics in Washington. “they don’t want to see as being coordinated by their finance ministers into doing this.”

Bernanke said in a speech yesterday that an intensifying credit crunch means officials must “consider” lowering borrowing costs.

In more typical market conditions, stocks rally when a Fed chief indicates he’ll reduce rates. Now, Bernanke’s message may have less power because traders already anticipated for weeks that policy makers would need to make that move, and because of rising concern even rate cuts may do little to immediately help banks scrambling to reduce their vulnerability to loan losses.

“In normal times, a rate cut would have a positive effect,” Gary Schlossberg, senior economist at Wells Capital Management in San Francisco, said yesterday. “What’s troubling the market” is concern about “the solvency and losses of major institutions. The market is uneasy because it doesn’t have a lot of information on what the depth of those losses will be.”

To contact the reporter on this story: Scott Lanman in Washington at slanman@bloomberg.net

Last Updated: October 8, 2008 09:28 EDT
By Scott Lanman

Source: Bloomberg

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