Worldwide Action, Interest Rate Cut
Posted on: October 9, 2008 - Email Article - Printable Version
Many investors woke up yesterday morning to a surprising news headline that six central banks moved in coordination to cut their respective interest rates. The coordinated effort came from the central banks in the U.K., Canada, Sweden, Switzerland, and the U.S. The 50 bps cut stimulated the pre-market trading, which led the futures to the major U.S. indexes higher. This rally was short-lived as the markets eventually moved lower during the day.
The Fed’s action has now brought their interest rate target down to 1.50% from 2.00%. This emergency move was speculated about for weeks, as the overnight credit markets came under severe pressure. The Fed also lowered their discount window, where they lend directly to banks, to 1.75% from 2.25%. Over the 6 months, many banks have taken advantage of borrowing directly off of the discount window in an effort to raise capital at a cheaper price than the LIBOR rate. One problem the Fed has been facing has been the spread difference between LIBOR and the Fed funds target rate. Historically over the past 2 years, LIBOR has been higher than the Fed Funds target by 30-50bps. In recent weeks, this spread has widened to over 200bps. 
According to Bankrate.com, current LIBOR rates are 4.14%, 4.32%, and 4.02% for 1 month, 3 months and 6 months LIBOR rates respectively. This move came before its regularly scheduled meeting of October 28-29. With this emergency cut, I wouldn’t expect another cut during this meeting. The meeting at the end of the month will be extremely important in guiding the markets. Many had speculated that 2.00% was the lowest that the Fed was going to go. Until recent weeks, members of the Fed had hinted that they wouldn’t cut rates further because of inflationary pressures and a deteriorating dollar. This surprise cut, proved that the Fed has more moves up their sleeve than was originally thought. The FOMC voted unanimously 10-0.
The Federal Reserve has been extremely active in cutting rates and providing liquidity in order to stabilize the financial markets and strengthen the banking system. Since August 2007, the Fed has cut interest rates by 375bps from 5.25% to their current target of 1.50%. In a statement released this morning, the Fed stated “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.”
If the Fed’s actions didn’t surprise investors this morning, the rate cut by the European Central Bank certainly did. The half-point rate cut shows how members of the ECB have re-evaluated the current market conditions and decided that in order to provide liquidity to the markets it was necessary to cut. Earlier this year, the ECB actually raised interest rates to 4.25% because of inflationary concerns. This half-point rate cut now moved the ECB interest rates down to 3.75%. Inflationary pressures were still a major concern for the bank, as annual inflation came in at 3.6% across the euro-zone, which was nearly double the ECB’s target of 2%. The ECB’s single mandate is to maintain stable prices throughout the region.
The Bank of England’s rate cut brings their interest rate target to 4.5%. This cut came a day early to their originally scheduled meeting tomorrow. According to an article in the Wall Street Journal, the central banks said in a joint statement that inflationary pressures “have started to moderate” due to declines in commodity prices. ” 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,” the statement said. “Some easing of global monetary conditions is therefore warranted.”
Central Banks from around the world are moving desperately to try to provide liquidity to the markets and restore any confidence that they can. More coordinated efforts like this one will most likely be the norm for the rest of the year. Interest rates around the world are still too high for economies to operate efficiently. It is necessary for world interest rates to be cut further. Some type of global liquidity fund may also be needed so that there is no threat of central banking failures in a particular region.
- Steve Murray
Disclosure: None.
Comments
