ECB and BOE Lower Interest Rates to the Historical Levels

12-05-2008 07:30

Central banks in Europe lowered their benchmark interest rates. European Central Bank cut rate by 75 basis points to 2.50 percent, the most aggressive move in ten years history of the bank. The Bank of England also voted to lower the bank rate by 100 basis points to 2.00 percent, the lowest level since 1951. Credit markets show some signs of improvement and for now it is more the fear of deflation which forces policymakers to continue to inject money into the system. Interest rates are headed to zero around the world and new measures may be used to stimulate growth.

ECB may be still behind the curve

While today's reduction by the ECB looks aggressive, the euro-area still has the highest interest rate among the G-7 members. Economic activities increasingly slow across the globe when recent data suggest that the economy in Europe is not in a better shape.

Unemployment has started to rise, inflation has fallen sharply, and manufacturing and service sectors continue to shrink. Some analysts believe that the ECB had been clearly behind the curve by being reluctant to ease monetary policy as fast as other central banks did.

According to the IMF, all major economies could fall into recession together for the first time since World War II. U.S., Germany, and Japan are officially in recession when the pace of growth slows noticeably in emerging economies like China and India.

Keeping powder dry

Price pressures continue to ease but at the cost of sharp slowdown in economic activities. A report last week showed inflation in euro-zone fell from 3.2 to 2.1 percent and it may give room for reducing interest rate further.

At the same time, some ECB's members still have doubts about the effectiveness of such bold actions, saying it may result in panic, affect market sentiment negatively, or at least leave the policymakers with no tools if this downturn be more prolonged than estimates.

Today's comment by Jean Claude Trichet, the European Central Bank President, might reflect that controversy. Speaking at a press conference after the rate decision, he said that he doesn't want to lose his options by reducing rate to "too low" levels.

Awaiting real effects

Currencies' reactions showed today that how balanced the market is. Pound and Euro both extends their declines against the dollar and Japanese yen before the interest rate announcements and rose just after that, ahead of economic data in the U.S.

After a period of extreme volatility, markets seem awaiting to see the effects of recent actions. In the U.S., Continuing Claims for receiving jobless insurance rose last week reflecting deteriorating job market. Factory Orders fell as much as 5.1 percent in October when uncertainties remain about the future of auto industry and possibility of a loan from the government.