Wednesday, October 8, 2008

Central Banks Coordinate Emergency Rate Cuts

Following crashing global stock markets, the world’s major central banks including the Federal Reserve, the Bank of England and the European Central Bank announced coordinated interest rate cuts.

In an emergency early morning announcement (7:00 AM ET), the Fed said it cut the Fed funds rate 50 basis points to 1.5 percent. It also cut the discount rate by the same amount.

"The Bank of Canada, the Bank of England, the European Central Bank, the Federal Reserve, Sveriges Riksbank, and the Swiss National Bank are today announcing reductions in policy interest rates," said the Fed.

This can be seen as a somewhat cosmetic move by the Fed since they have been aggressively pumping money into the system in recent days, anyway. As we have pointed out, the Fed has pushed the funds rate far below the previous Fed target rate of 2%. Indeed, the Fed market activities in recent days has pushed rates even below the new target. From September 19, the Fed Funds rate has traded for the most part significantly below 2%.

Further, as we pointed out yesterday, the Fed's new ability, to pay interest on reserves held by commercial banks at the Fed, dampened the need for rate cuts, as the technical ramifications of the Fed interest rate payments will allow it to add as much reserves as it desires at a given target rate, so long as the target is above the real interest rate for reserves. In comments later yesterday, Bernanke supported this interpretation of the ramifications of the Fed paying interest on reserves held at the Fed.

However, the market not grasping the intricacies of Bernanke's new advanced money printing ways, reacted strongly to the news of a cut in the old fashioned Fed policy tool, the Fed Funds rate. In overnight trading, after the emergency rate cut announcements, the Standard & Poor’s 500 stock index futures climbed by 2%.

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