Central bank rate cut fails to reassure

A surprise cut in interest rates by the European Central Bank (ECB) came as a sign that recession fears have overtaken those concerning inflation, as European financial markets yesterday continued to tailspin despite government attempts to prop them up.

Unprecedented rate cuts 

“The recent intensification of the financial crisis has augmented the downside risks to growth and thus has diminished further the upside risks to price stability,” the central bank said in a statement released yesterday (8 October). 

The decision was part of unprecedented action in which six of the world’s most important central banks, including the US Federal Reserve and the Bank of England, simultaneously implemented emergency cuts of half a percentage point. 

This brings the ECB interest rate down from 4.25% to 3.75%, following nine consecutive raises (EURACTIV 04/07/08), while the Federal Reserve cut brings lending rates down to just 1.5% in the US. 

ECB President Jean-Claude Trichet said the coordinated action would help restore confidence. The ECB also announced it would be offering the eurozone’s commercial banks unlimited liquidity from now on at its weekly auctions in a bid to further improve credit access.

But early signs showed that the mass rate cut had failed to quell agitation on European and US money markets, with stocks yesterday continuing to fall on recession fears. 

BusinessEurope, the federation of European employers, nevertheless hailed the cut as “the right decision in a context of intensifying financial market turbulence, declining inflation and growing uncertainties about economic prospects”. 

“This joint intervention shows that the ECB and its counterparts across the world will take necessary actions to contain the ongoing crisis. This sends a message of confidence not only to financial markets and banks but more importantly to companies and citizens,” it stated. It further called on European governments to send “an unambiguous signal for a coordinated European approach” and to strengthen regulation where needed. 

New group to steer joint EU response 

The EU has been much criticised for its inability to come up with a quick and effective joint response to the crisis. Speaking in the European Parliament yesterday, Commission President José Manuel Barroso announced his intention to set up a “permanent steering group on the financial crisis” within the College of Commissioners to reflect on how rules should be changed to improve supervision of financial institutions. The group will be chaired by Barroso himself, and includes Commissioners Almunia (in charge of economic and financial affairs), Kroes (competition) and McCreevy (internal market). 

The EU executive will also be assisted by a new independent High Level Group, chaired by former IMF Director-General Jacques de Larosière. 

“We need to launch a reflection process in order to build common ground,” Barroso explained, adding that proposals already on the table such as Solvency II (EURACTIV 08/10/08) and the capital requirements directive (EURACTIV 02/10/08) are “the strict minimum we need”. “Indeed, I am convinced we will have to go much further,” he stressed. 

He further confirmed that the Commission would next week propose new rules on accounting and on increased supervision for credit rating agencies. 

But he was slammed by Socialist Group leader Martin Schulz for coming up with too little, too late. “Measures to deal with the crisis announced by Commission President José Manuel Barroso today had been called for by the Parliament some years ago,” stressed Schulz, adding: “We have had to listen for years to how the market would sort it all out and how one day we were all going to benefit from the market. Well, the house is on fire.” 

IMF predicts doom and gloom 

As if to confirm this, the International Monetary Fund yesterday issued its bleakest forecast in years, saying the world economy was “entering a major downturn,” with both the United States and Europe either in or on the brink of recession amid “the most dangerous financial shock in mature financial markets since the 1930s”. 

“In advanced countries, the crisis is now being driven by a downward spiral of loss of confidence and trust,” said IMF Chief Economist Olivier Blanchard, adding that the effects were now also spreading to consumers and firms. 

He further warned that financial conditions were likely to remain “very difficult, even assuming that actions by the US and European authorities succeed in stabilising financial conditions and in avoiding further systemic events”. 

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