NEW YORK, 18 August 2007 — European and US stocks rebounded yesterday as the US Federal Reserve slashed the lending rate it charges commercial banks in the most dramatic twist since fears of a credit crunch gripped world markets last week.
The announcement by the US central bank, aimed at boosting damaged investor confidence, helped share prices to recover from traumatic losses over the past week amid fears of a financial crisis linked to the troubled US housing market.
The Fed cut its so-called discount window rate by 50 basis points to 5.75 percent citing “increased uncertainty” in the financial markets.
“The markets have taken this move as a positive step, but this may prove to be a knee-jerk rally,” said Martin Slaney, head of spread betting at GFT Global Markets in London. “This looks like a U-turn from the Federal Reserve, which only a few days ago suggested it was not too concerned about the credit squeeze.”
Also yesterday, the US central bank injected $6 billion into the banking system.
In initial Wall Street trade, the Dow Jones Industrial Average jumped 1.62 percent to 13,054.12 points, the tech-rich NASDAQ added 2.36 percent to 2,508.85 points and the broad-market Standard Poor’s 500 rose 1.53 percent to 1,432.91.
Markets in London, Frankfurt and Paris jumped back into the black, erasing earlier losses, as European traders were also comforted by the Fed’s move to loosen monetary policy.
London’s FTSE 100 index of top shares surged by almost 4.00 percent to move back above 6,000 points, while stocks also soared by around 3.0 percent in Frankfurt and Paris.
Analysts said that the Fed move increased the chances that the Federal Reserve would slash its key federal funds rate — which stands at 5.25 percent — in the coming months.
Lower lending rates tend to support rising share prices because they decrease company loan repayments, while increasing consumers’ disposable incomes.
However, Slaney of GFT Global Markets sounded a downbeat note about the Fed’s action. “The market turbulence has forced the Fed’s hand here, and whilst an emergency cut might give the markets some temporary relief, some might say there is a sense of panic coming from the Fed. An emergency cut such as this may have worked to calm markets in previous times of turmoil such as after 9/11, but this time it could prove counterproductive,” the analyst added.
The move to cut the discount rate will not have a major impact on consumer interest rates in the way that cutting the federal funds rate triggers an immediate drop in banks’ prime lending rate, the benchmark for millions of consumer and business loans.
Trading began yesterday with further big falls for Asian shares, as investors reacted to more bad news linked to the US housing market, which is already beset with concerns over the slumping high-risk subprime loan sector.
Heavy selling in Tokyo — Asia’s largest bourse — quickly spread across the continent, with major markets there losing more than five percent. Traders are worried that the US problems could spark a credit crunch — a tightening of global lending conditions as banks restrict access to credit to investors and companies alike.
Japanese shares finished with a massive 5.42-percent loss, suffering the biggest one-day points drop since April 2000. Hong Kong share prices closed 1.40 percent lower, but reversed earlier sharp losses of 6.0 percent due to bargain hunting, dealers said.