[R-G] Central Banks Coordinate Global Cut in Interest Rates

[Anthony Fenton]

October 9, 2008
Central Banks Coordinate Global Cut in Interest Rates
By CARTER DOUGHERTY and EDMUND L. ANDREWS
http://www.nytimes.com/2008/10/09/business/09fed.html?pagewanted=2&_r=1&bl&ei=5087&en=6c2c0d7539595be6&ex=1223611200

In a move of unprecedented scope, the world’s major central banks  
lowered their benchmark interest rates Wednesday, a coordinated effort  
to halt a collapse of share prices and a freeze in credit markets that  
threatens to set off the first global recession since the early 1970s.

The action failed to calm gyrating markets, however, amid the growing  
realization that a serious and prolonged recession may be difficult to  
avoid.

The Federal Reserve, the European Central Bank, the Bank of England  
and the central banks of Canada and Sweden all reduced primary lending  
rates by a half percentage point. Switzerland also cut its benchmark  
rate, while the Bank of Japan endorsed the moves without changing its  
rates.

In another monetary first, the Chinese central bank joined the effort  
— without explicitly saying it was doing so — by reducing its key  
interest rate and lowering bank reserve requirements to free up cash  
for lending.

The Fed’s benchmark short-term rate now stands at 1.5 percent. The  
European Central Bank’s is 3.75 percent.

Taken together with other moves in the United States, Britain and  
Continental Europe in the last few days, the rate cuts look like part  
of a broader, global strategy that embraces aggressive use of monetary  
policy and taxpayer recapitalization of ailing banks, generating  
cautious optimism among crisis-weary analysts.

“The gravity of the times requires out-of-the box responses,” said Jim  
O’Neill, the chief global economist at Goldman Sachs. “Atop of all the  
other things we have seen this week, it gives me great confidence.”

The efforts led to a brief rally on European stock markets, but it  
quickly fizzled. Benchmark indexes were off by 5 percent to 6 percent  
in Germany, Britain and France. Markets in New York were trading in a  
400-point range, swinging between positive and negative.

Credit market conditions remained extremely tight, with the gap  
between yields on safe, three-month government securities and the rate  
that banks charge one another for loans of the same duration rising to  
more than 4 percentage points not long after the central banks acted —  
showing financial institutions remained deeply concerned about lending  
to one another.

Federal Reserve officials said Wednesday’s action was the first time  
ever that the Fed had coordinated a reduction in interest rates with  
other central banks, though the United States has periodically joined  
with other countries to intervene in currency markets to stabilize  
foreign exchange rates.

The closest thing to a precedent came in November 2001, when the Fed  
and the European Central Bank announced a rate reduction on the same  
day. But those actions were nominally independent, and they did not  
involve any additional foreign central banks.

The cut came despite what had been a divergence of views between the  
United States and Europe ever since the financial crisis erupted in  
August 2007. The European Central Bank had been much more reluctant to  
lower interest rates, because policy makers there tended to see the  
mortgage meltdown primarily as an American problem with secondary  
ripple effects in Europe.

But any lingering comfort outside the United States evaporated in the  
last week, as money markets froze up around the world and major  
corporations and banks across Europe began suffocating from their  
inability to do even routine financial transactions.

Making matters worse, none of the epic emergency measures taken in the  
United States — the passage of a $700 billion bailout plan to buy up  
distressed securities; a doubling and redoubling of emergency loan  
facilities at the Fed to $900 billion on Monday; and the Fed’s  
unprecedented decision on Tuesday to start buying up short-term  
commercial debt for businesses of all types — had prevented the stock  
markets from plunging at vertigo-inducing amounts day after day.

Some analysts responded positively to the news.

“At last, a coordinated show of force,” Ian Shepherdson, chief United  
States economist at High Frequency Economics, wrote in a note. “The  
move is to be applauded but there is more to come. The playbook to  
avoid depressions says rates need to be as close to zero as possible.”

Other economists were cautious about whether the various measures  
would be successful, after previous plans like the United States’  
economic bailout have not halted steep declines in share prices.

“There’s no silver bullet for these problems,” said Derek Halpenny, a  
currency strategist at Bank of Tokyo-Mitsubishi UFJ in London. “But  
the actions by the Fed on Tuesday, the U.K. government’s bailout plan  
today and the bit-by-bit approach European governments are taking show  
the authorities are getting more proactive.”

The central feature of the acute credit crunch, which began in the  
United States and is now spreading rapidly in Europe, is the  
reluctance of banks to lend at any rate because they have taken such  
heavy losses already and are hoarding cash.

Not only does that interrupt the normal flow of credit for activities  
as basic as modernizing production lines or meeting payrolls, it gums  
up the normal mechanisms central banks use to ease credit and  
stimulate economic activity.

“The key lesson is when you face a confidence issue where the market  
participants no longer trust each other, the conventional  
macroeconomic tools are not as effective,” Olaf Unteroberdoerster, the  
International Monetary Fund’s representative in Hong Kong, said  
Wednesday.

The Sept. 15 bankruptcy filing of Lehman Brothers and subsequent near- 
failures of European banks drained financial market confidence  
globally. And whatever the shortcomings, rate cuts do help confidence,  
even if they have lost their power to spur stock market rallies,  
analysts said.

In some respects the rate cut was should not have been unexpected. On  
Tuesday, the chairman of the Federal Reserve, Ben S. Bernanke, had  
telegraphed such a move. In a speech, he said that the financial  
turmoil had forced the Fed to downgrade its already gloomy economic  
outlook and investors had all but assumed that it would lower the  
benchmark Federal funds rate no later than its next scheduled policy  
meeting on Oct. 28 and Oct. 29.

Until a few weeks ago, Fed officials had tried to separate its rescue  
efforts in the financial markets from problems of the underlying  
economy.

After a rushed series of rate reductions last fall and early this  
year, bringing the overnight Fed funds rate down to 2 percent in  
April, the central bank had concentrated its efforts on injecting  
hundreds of billions of dollars into the financial system to keep  
banks lending to one another and to their customers. But policy makers  
held back from further reducing interest rates, which reduce the  
overall cost of money, because they were worried about rising  
inflationary pressures.

Consumer prices have climbed sharply, largely because of huge  
increases in energy and commodity prices. As recently as the Fed’s  
policy meeting three weeks ago, the central bank’s official position  
was that its concerns about slowing economic growth were roughly equal  
to its concerns about rising prices. In reality, many policy makers  
were more worried about the onset of a recession — which many private  
economists say has already arrived. But there were still disagreements  
among members of the Federal Open Market Committee, which sets  
interest rates.

Contributing reporting were Keith Bradsher, David Jolly, Martin  
Fackler, Bettina Wasserman, Michael M. Grynbaum, Hilda Wang and Peter  
Gelling.