Historic move attempts to create global policy response

ANALYSIS:YESTERDAY'S INTEREST rate cut by six central banks in North America and Europe is a historic move that attempts to produce for the first time a comprehensive international monetary policy response to the economic risks of the credit crisis.

The transatlantic move marks a recognition that growth had already weakened across the industrialised world even before the latest escalation of financial stress.

The combination of an increasingly global downturn, plus global financial stress, raises the likelihood of rising unemployment in leading economies and has already depressed commodity prices, making the inflation outlook less worrying.

Policymakers see the danger that the feedback loop between financial-sector weakness and economic weakness that has menaced the US since the start of the credit squeeze may now be replicating at global level.

Since the financial markets are global, the threat to growth is global, and falling commodity prices are global, it makes sense to address the economic risks through global monetary easing.

The US Federal Reserve, Bank of Canada, European Central Bank (ECB), Bank of England, Swiss National Bank and the Swedish Riksbank would in any case have moved in convoy to ease rates in the coming weeks.

China's move - and the rate cut by the Reserve Bank of Australia earlier this week - further strengthens the notion that this is a truly global effort. However, for the six central banks to act as one has a number of advantages.

By acting simultaneously, the banks maximised the chance that their actions might shock the credit markets back to life and bolster collapsing confidence among households and businesses.

By contrast, Fed chairman Ben Bernanke was sceptical that a Fed rate cut on its own - that was already priced into the market - would do much to boost growth or ease market stress.

The co-ordinated nature of the move made it less embarrassing for central banks to U-turn on rates - particularly the ECB, but also the Bank of England and the Fed, which adopted a neutral balance of risks at its last policy meeting.

And it avoided the risk that one-at-a-time rate cuts would produce disorderly swings in currency markets. This was a particular concern for the Fed and Bank of England, since the dollar and sterling have suffered bouts of extreme weakness since the credit crisis began. The ECB did not want to see the euro swing higher against the dollar even on a temporary basis following a Fed emergency rate cut.

The move also reassured the markets that the world's central banks were operating in harmony, at a moment when governments around the world are adopting emergency actions - such as bank deposit guarantees or recapitalisation plans - that are plainly not co-ordinated and often have harmful spillover effects.

In particular, the central banks were signalling that there would be no "beggar-thy-neighbour" efforts at competitive devaluation.

Pulling this off was no mean feat. Since the start of the credit crisis the world's central banks - in particular the Fed and ECB - have appeared to take a different approach. The Fed cut rates early and aggressively, to lean against the widening of borrowing spreads in the market and pre-emptively address the risk to growth, while the ECB adopted a "separation principle" distinguishing between liquidity operations and rate policy.

Yesterday's action marks a coming together of these two approaches. It represents a globalisation of the Fed strategy of using rate cuts to ease or offset what would otherwise be a tightening of financial conditions in order to reduce the danger to the world economy from the credit crisis.

But is also respects the ECB separation principle, since the rate cuts are explicitly targeted at the economy rather than the financial system, and are justified by the change in the inflation outlook. - ( Financial Timesservice)