Wall Street economists and strategists explain the significance of the coordinated global interest rate cuts—and consider what might happen next
From Standard & Poor's Equity ResearchCentral banks are trying anything, and everything, to shore up confidence in the global financial system amid the current crisis. On Oct. 8 they acted in concert: The U.S. Federal Reserve, Bank of England, and European Central Bank announced a coordinated interest rate cut of 50 basis points, with the Bank of Canada and Sweden's Riksbank also cutting rates. On top of that, Britain announced a plan to recapitalize its leading banks to the tune of £50 billion.
What are the ramifications of these historic moves? Here are insights from Wall Street economists and strategists compiled by BusinessWeek and Standard & Poor's MarketScope on Oct. 8:
David Wyss, Standard & Poor's
This morning the Federal Reserve, Bank of England, and European Central Bank announced a coordinated cut of 50 basis points in their base interest rates. We had expected a rate cut in such a coordinated fashion, but it came a bit earlier than expected, perhaps because of the weakness seen in the stock market. We expect rates to be cut more by yearend, with the federal funds rate likely to fall to 1%, its low of five years ago. Markets reacted positively early to the news, but whether this will unlock credit markets remains to be seen. The Fed and Treasury are pulling out all the stops to avoid a Japanese-style debacle.
Mark Vitner, Wachovia Economics Group
The $2 trillion question is will all this coordinated rate-cut action work? The Fed has already cut interest rates seven times since last September, bringing the federal funds rate down from 5.25% to the current 1.5%. Most other major central banks, notably the European Central Bank, have been a bit slower in cutting. We look for additional rate cuts from major central banks. In our view, the Fed will cut another 50 basis points at its regularly scheduled [Federal Open Market Committee] meeting on Oct. 29. A final rate cut of 25 basis points in December or January also seems likely. We look for the ECB to cut another 75 basis points over the next few months, and we expect the Bank of England to bring its main policy rate down another 150 basis points by early next year. In the near term, lower rates may help to restore some confidence. In the longer term, lower rates should help to stimulate spending.
Michelle Meyer, Barclays Capital
We are not surprised by the coordinated central bank rate cuts. We argued last week that the spillover of the U.S. financial turmoil to Europe makes a "coordinated policy response more likely." We do not believe the aggressive policy response ends here. The FOMC is likely to continue to slash interest rates and to expand its balance sheet further. We expect the FOMC to cut interest rates by another 25 basis points at the Oct. 28-29 FOMC meeting, followed by three more 25-basis-point cuts. This will bring the terminal rate to 0.50% by the second quarter of 2009.
Continued coordinated global action to combat the financial turmoil, perhaps aimed more directly at the banking system and troubled asset markets, would not be surprising. Watch this week's G7 finance ministers and central bank governors meeting in Washington for overtures in that direction.
The Fed's rate cut was largely signaled by Fed Chairman Ben Bernanke in yesterday's speech, though Wall Street focused on his downbeat outlook on the economy. The markets will remain fixated on today's action, hoping this is the silver bullet to restore confidence and market order, as central bank officials, and especially the Fed, are running out of bullets.
Keith Wade, Schroder Investment Management
The British government has today announced it is planning an injection of capital into the British banking sector that will effectively result in a partial nationalization of the country's major banks. There will also be conditions for these banks in terms of how they act, how they lend, and their dividend and compensation policies.
The British approach to shoring up its financial sector is somewhat different from the action already taken in the U.S. The $700 billion Troubled Assets Relief Program (TARP) that has been approved by the U.S. Congress is using government money to buy "toxic" assets, such as mortgage-backed securities, from ailing banks. What the British government has proposed by contrast is a more direct recapitalization of the sector. In previous financial crises, this approach has been more successful in restoring market confidence.