Central Bank Execution-Style Rate Cuts

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.

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.

Rate Levels
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.

Stocks at first rallied after the announcement, then turned 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.

The Standard & Poor’s 500 Stock Index fell 2 percent to 975.87 at 12:51 p.m. in New York, after plummeting 15 percent in the past five trading days. Europe’s Dow Jones Stoxx 600 Index slumped 6 percent after a drop of as much as 7.8 percent. Japan’s Nikkei 225 Stock Average lost 9.4 percent to 9,203.32 earlier today, before the announcement.

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 crisis already prompted the U.S. to enact a $700 billion program to buy troubled assets from banks in an effort to prop them up. U.K. banks will get a 50 billion-pound ($87 billion) government bailout, while Spain will spend as much as 50 billion Euros to buy bank assets. European governments have also moved to rescue banks Fortis, Dexia SA and Hypo Real Estate Holding AG.

The U.S. Treasury said today it sees “severe dislocations” in the government bond market and plans to sell more debt to address shortages. The market problems “are across the Treasury market curve” and are primarily affecting medium- and long-term debt, from two-year notes through 30-year bonds, a Treasury official told reporters.

The Fed’s Open Market Committee, which voted unanimously for today’s 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.”

Bernanke Message
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.

“This is an extraordinary circumstance,” said Former Fed Governor Laurence Meyer, now vice chairman of Macroeconomic Advisers LLC. “If markets are totally frozen it doesn’t help. It certainly builds confidence psychologically.”