Fed Orders Emergency Rate Cut of Half a Percent
Howard Schneider - Washington Post Staff Writer
The Federal Reserve and a consortium of European central banks today announced a half a percentage point reduction in a key interest rate, a coordinated effort to stave off an economic slump even as they continue struggling to tackle a crisis in global financial markets.
The announcement -- dramatic, given that central banks closely guard interest rates as a key component of national policy -- came on what promised to be a turbulent day on markets as investors evaluated a quickly-changing landscape. Along with the interest rate cut investors were also evaluating news of a major government bailout of U.K. banks.
European exchanges were nevertheless lower by about 4 percent, while Asian indexes suffered another major selloff overnight. U.S. indexes fell more than 2 percent when trading opened, quickly rebounded to a gain of about the same amount, then fell again.
The rate cut, hinted at by Federal Reserve Chairman Ben S. Bernanke yesterday then approved by the central bank overnight, reduces the target federal funds rate to 1.5 percent from 2 percent. The vote was unanimous among the 10 members of the Federal Reserve's Open Market Committee. Joining the rate cut were central banks in Canada, England, Sweden, Switzerland and the European Central Bank. Central banks in China, Hong Kong, Kuwait and the United Arab Emirates acted separately to cut rates, a move the Australian central bank had taken the day before. More Arab central banks are expected to do the same in coming days.
With commodity prices falling and concerns about an economic slowdown taking root around the globe, the banks in a joint statement said it was time to shift the focus from controlling inflation to bolstering growth. The Fed's target rate affects an array of other interest rates at commercial banks. Lower rates make it cheaper for companies to borrow to invest in offices, factories and equipment, and bring down the cost of a variety of consumer credit options, such as bank credit cards and auto loans.
While recent U.S. policy efforts, including the $700 billion financial bailout package enacted last week, have focused on stabilizing the financial system and ensuring an adequate supply of cash for banks, the interest rate cut addresses more directly a developing economic slowdown.
Major central banks around the world have coordinated closely throughout the current crisis, but the joint action on interest rates is the strongest collective statement yet of how serious they perceive the problem to be.
As recently as last week, for example, the European Central Bank had expressed a reluctance to reduce rates and had been raising them to combat inflation.
But the ECB joined with the other banks in stating that "inflationary pressures have started to moderate in a number of countries . . . The recent intensification of the financial crisis has augmented the downside risks to growth."
The Fed was not scheduled to meet again on monetary policy until late this month -- an eternity in a fast-moving crisis that has shuttered some of Wall Street's marquee names and forced governments worldwide to bail out even seemingly healthy banks.
In a separate statement, the U.S. central bank made clear that the financial crisis, coupled with rising unemployment, stagnant wages and other underlying economic problems, had become a toxic combination.
"Incoming economic data suggest that the pace of economic activity has slowed markedly in recent months," the Fed said, while the financial crisis was "further reducing the ability of households and businesses to obtain credit."
In it annual report on the economy, the International Monetary Fund predicted slowing growth globally and a rising risk of recession in the U.S.
"The world economy is now entering a major downturn in the fact of the most dangerous shock in mature financial markets since the 1930s," the era of the Great Depression, the IMF said.
The Bank of Japan did not participate in the interest rate cut but issued a statement supporting the joint action. Rates in Japan are already low enough, the bank said, to encourage economic growth.
Analysts have been predicting or calling for some sort of joint move by the major central banks, partly to show that they were willing to work together to uphold markets that, at least to some degree, are being shaped by fear.
"At last, a coordinated show of force," said Ian Shepherdson, chief U.S. economist with the High Frequency Economics consulting firm. "The move is to be applauded, but there is more to come," Shepherdson said, predicting the Fed will further ease rates in coming months.
The Fed last cut rates in April, and in the intervening months paid close attention to energy and commodity prices and other indicators of inflation. But it also watched as businesses slashed hundreds of thousands of jobs, consumer spending slowed, and home values -- a key source of household wealth -- continued steadily downward.
European growth has also slowed. That, combined with the depth of the financial crisis, led the European central banks to relax their inflation concerns and join the Fed.
Coming after an unprecedented intervention by governments into the market in recent weeks -- from bank bailouts and corporate rescues to a rewriting of basic economic policy -- central bankers were becoming nervous that the situation has not shown more obvious signs of improvement, said Howard Archer, an economist with the Global Insight consulting firm who specializes in the U.K. and Europe.
"The various steps taken globally in recent days to try to alleviate the financial sector crisis have had very little impact," Archer wrote in an analysis of the rate cut. "Consequently, it is clear that the authorities now believe that coordinated, wide-ranging action is the only effective way of dealing with the problem."
Washington Post correspondent Ellen Knickmeyer in Cairo contributed to this report.
www.washingtonpost.com/wp-dyn/content/article/2008/10/08/AR2008100800847.html