U.S. share prices rebounded strongly Friday after the U.S. Federal Reserve Board approved a cut in a key bank lending rate–a surprise step taken to quell the storm battering global stock markets. But even with the Fed’s move, the current situation does not fill us with optimism for the near-term prospects of the markets.

The Fed cut the discount rate–the interest rate the Fed charges on loans to banks–by half a percentage point to 5.75 percent. This was the first emergency cut approved by the Fed since immediately after the Sept. 11, 2001, terrorist attacks on the United States. But the U.S. central bank left the federal fund rate–its key short-term rate–unchanged at 5.25 percent.

In a statement, the Fed expressed concern about a widening credit crunch and turbulence in stock markets set off by defaults on U.S. subprime mortgages by low-income earners.

Referring to the U.S. economy, the statement said “downside risks to growth have increased appreciably.”

The Fed’s rate cut is designed to stem the jumpiness ravaging global financial markets and to arrest sliding stock markets.

The cut sent stocks on the New York Stock Exchange soaring Friday and put the brakes on the global financial woes–at least for now.

On the foreign exchange market, the steep appreciation of the yen against the dollar has been mitigated.

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Coordinated action

In coordination with the European Central Bank and the Bank of Japan, the Fed has been injecting huge amounts of liquidity into the short-term money markets. Their concerted actions were aimed at preventing financial institutions from experiencing a cash crunch due to the subprime mortgage problem.

The discount rate is the interest rate the Fed charges on loans to financial institutions, which have had a hard time procuring funds. However, the funds provided at the discount rate are restricted, and many observers say the system applying the rate does not go far enough to be effective.

The Fed’s injection of huge amounts of liquidity into the market and lowering the discount rate will certainly provide a sense of security to market players.

The Fed left the federal fund rate unchanged apparently because of the need to remain vigilant against inflationary pressures at a time when the U.S. real economy has been robust for a long time.

The U.S. central bank apparently wanted to send a message that the discount rate cut was an emergency measure to calm the volatile markets, but not a change to easing its monetary policy.

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Crisis far from over

Some observers, however, say the credit crisis stemming from the subprime loan fiasco is a deep-rooted problem that cannot be resolved easily, and that the reduced discount rate will only have a limited effect. Concerns remain that the high-flying U.S. economy may slow down.

If fears among market players are stoked again, financial storms could buffet stock and foreign exchange markets once more. The Fed might then feel pressured to consider an additional rate cut.

The Bank of Japan will hold a policy meeting Wednesday and Thursday to consider whether to increase its key interest rate.

After the Fed reduced the discount rate, it became more important for Japan’s central bank to take concerted actions with monetary authorities of major economies to stabilize the market.

All things considered, we think the central bank likely will keep the key rate unchanged at this week’s policy meeting.

Source:

http://www.yomiuri.co.jp/dy/editorial/20070819TDY04009.htm