The Federal reserve system (the fed) that performs the functions of the Central Bank, on Tuesday, March 3, lowered the benchmark interest rate to a level of 1-1. 25%, lowering it from 0.5 PP (1.5–1.75 percent), the message of the fed. This decision was unplanned — the fed meeting was scheduled for 17-18 March, says RBC.
The decision in the fed attributed the spread of coronavirus infection COVID-19, which creates additional risks for economic activity.
In anticipation of the announcement of the fed’s decision Bloomberg said that officials from the administration of U.S. President Donald trump insist on lower rates to minimize the effects of distribution COVID-19 for the economy.
Because of the coronavirus, the turnover of global trade will shrink by 3.75% in 2020, warned the Organization for economic cooperation and development (OECD). In its forecast, because of lower demand in OECD countries will slow price growth, and Central banks will be forced this year to reduce the key interest rates on average by 1 percentage point.
When the fed took emergency action on rate reduction
The last time the fed’s unscheduled rate cut of more than 11 years ago:
October 2008 — after Lehman Brothers collapse;
January 2008 — after the fall of the stock markets and signals of the upcoming recession in the U.S.;
August 2007 — amid the crisis in the subprime mortgage market;
September 2001 — after the terrorist attacks in new York;
April 2001 — against the backdrop of the increased probability of a recession in the U.S. economy;
January 2001 — after the collapse of the dot-com;
October 1998 — after the financial crisis in Russia and the collapse of hedge Fund Long Term Capital Management, pogorevshikh on investments in Russian t-bills.
On the possibility of an emergency solution in the situation with coronavirus, the fed has hinted on February 28.
“We will use our tools and we will act accordingly to support the economy,” — said in a statement the regulator.
The fed reduces the interest rate from 2019, but in cautious mode — in steps of 0.25 percentage points (last October). From 0.5 p. p. rate in the US fell for the last time in 2008. Prior to the latest round of reduction of the fed more than ten years, or increased, or kept the bet. The reduction to the range of 1-1,25% means the interest rate return to the levels of 2017.
The stock market reacted positively to the fed decision. The S&P500 index rose 2.5%, the Dow Jones up 2.3%, the NASDAQ by 2.4%. Soon, however, the indices have returned to those positions, which were before the fed decision. The US dollar index on news of rate is also decreased.
Other measures the fed
The fed also instructed the trade transaction desco at the Federal reserve Bank of new York to conduct operations one-day reverse REPO to banks at the rate of 1% with a limit of $30 billion a day at one company. During the reverse REPO, the Federal reserve buys securities, increasing liquidity in the system (with an obligation to sell them back in a day). Operation REPO and reverse REPO transactions need the fed to maintain its key interest rate in the target range (now reduced to 1-1. 25%).
To the emergency the fed’s decision, rates on the overnight REPO market with the Federal reserve reached 1.8 percent it was above the target range for the key rate. To prevent a surge in short-term rates, the fed is pouring liquidity into the financial sector. Previous unexpected increase in rates was recorded in September 2019, when the liquidity in this market is abnormally decreased, and short-term interest rates on REPO operations jumped to 10%.
The measures taken by the fed, is unlikely to lead to significant growth in aggregate demand, writes in his review chief economist at ING Bank James Knightley. However, lower rates can help to alleviate stress in the financial system and improve investor sentiment, he said. Goldman Sachs analysts earlier predicted that the fed will reduce the total rate by 1 percentage point in the first half of 2020.
“The fed surprised the market by its decision, for the first time in several years, and is an indicator of the fact that it predicts a worse scenario for global growth compared with those that were previously predicted, says economist for Russia and CIS “Renaissance Capital” Sophia Donets. — This step will somehow support the market, although volatility will persist to resolve the situation with coronavirus. Damage global growth this year is already inevitable. From this point of view, the reaction is justified.” Bloomberg notes that the fed’s decision could lead to a “wave” of reduction of interest rates worldwide, although the EU and Japan, resources for less — where rates are already in negative zone.