Central Bank Rate Cuts: Initial Reaction Positive

Posted by: Jack Ewing on October 08

Morgan Stanley economists have already coined the phrase “virtual global central bank.” While European governments are still feeling their way toward coordinated action, central banks around the world displayed unprecedented teamwork. In the U.S., the euro zone, Britain, Canada, Sweden and Switzerland, central banks cut their key interest rates by 50 basis points on Oct. 8. China’s central bank made a smaller cut, and Australia, Hong Kong and Israel have cut in recent days.

The decisive action by the central banks, almost more than the rate cuts themselves, helped restore confidence and immediately won praise from bank economists. “It shows that central banks despite their different traditions, styles and strategies are willing and able to work and act together,” Morgan Stanley economist Joachim Fels said in a note to investors. “This is a very important signal to markets and the public at large.”

While central bank watchers had begun predicting rate cuts soon, few expected such a steep, coordinated move. The element of surprise helped increase the impact. “The central banks have shown their commitment to stopping the fire on financial markets from spreading,” wrote Rainer Singer at Vienna-based Erste Bank. “The close cooperation proven by the coordinated action could support confidence.”

Nor did anyone seem bothered by the ECB’s willingness to cut rates even though inflation is still higher than the central bankers would like. “One shouldn’t worry too much about inflation risks in this exceptional situation,” wrote economists at Dresdner Bank in Frankfurt. “Weak global growth and the sharp drop in the price of oil will minimize upward price pressure.”

But will the action calm investors and encourage banks to start lending to each other again? Initially markets continued their declines. After a brief rally, Germany’s benchmark DAX Index fell more than 5%. U.S. stocks also fell. But it may take several days for the cuts to do their work. Even a measure of stability would be welcome.