coordinated rate cut

[yesterday]

In an historic move, the Federal Reserve, the European Central Bank, and many of the word's major central banks enacted a rate cut designed to contain the global credit crisis and support the worldwide economy. Stocks were initially higher following the coordinated actions, and markets in Europe pared losses. But the initial enthusiasm is being tempered by a lack of confidence in the credit markets and concerns the global economy is teetering on the edge of a recession.

Historic global rate cut

The Federal Reserve, along with the European Central Bank, the Bank of England, the Bank of Sweden, the Bank of Canada, and the Swiss National Bank acted together to cut rates as the Fed said that the recent intensification of the financial crisis has augmented the downside risks to growth and has diminished the upside risks to price stability. The Fed cut rates by 50 basis points to 1.5%, and the European Central Bank, which has resisted rate cuts this year, cut its key rate by 50 bp to 3.75%. The Bank of England, the Swiss National Bank, Bank of Canada, and Swiss National Bank also reduced their key rates by one-half percentage point.

The Bank of Japan welcomed the action but noted that at 0.50%, its main lending rate is already "very low." Shortly after the decisions were released, the central bank in Hong Kong acted in a similar fashion and slashed rates by 50 basis points. The People's Bank of China also reduced interest rates and cut its reserve requirement amid signs that the fast-growing economy is slowing. The unprecedented global action speaks volumes about the severity of the financial crisis and the desires of central banks to unthaw frozen credit markets and prevent the financial crisis from escalating.

UK rescue plan

European stocks have significantly pared losses following the global decision to slash interest rates but remain lower due to worries that the financial and banking woes are escalating. The UK said it will inject 50 billion pounds ($87 billion) in the banking system in order to recapitalize banks and prevent a breakdown in its banking system. Institutions that are included in the rescue plan include Barclays (BCS $18), the Royal Bank of Scotland (RBS $2), and six other major banks. The Bank of England also said it will provide at least 200 billion pounds to banks under a special liquidity scheme in order to encourage intra-bank lending. The initial reaction did little to help credit markets as the overnight Libor lending rate surged from 3.93% to 5.38% and the three-month Libor rate rose from 4.32% to 4.52%.

Elsewhere, the global panic in emerging markets forced down Russian stocks by more than 10% in the first 30 minutes of trading before authorities halted trading. Ukraine, Romania, and Indonesia also stopped trading as shares plunged amid worries about the global banking system and expectations that worldwide growth is poised to slump. Commodities, which drive a significant portion of developing economies, continue to fall, but persistent anxieties are supporting gold prices.

Tokyo shattered

Rising worries about a global recession knocked down the Nikkei 225 Index in Tokyo by 9.4%, the worst decline since 1987. Shares of Toyota (TM $68) extended losses for the fifth consecutive day and fell 11% after the Nikkei financial daily said the leading automaker might lower its full-year profit outlook, but near the close, a senior executive said the company was not contemplating a reduction in its current forecast. Meanwhile, the growing financial crisis and recession fears leaned heavily on stocks, with South Korea losing nearly 6% and shares in Hong Kong falling over 8%.

Schwab Center for Financial Research - Market Analysis Group