Central bank, Fed both slash interest rates

With world stock markets reeling at the prospect of a sharp downturn in the U.S. economy spreading around the globe, the Bank of Canada and the U.S. Federal Reserve both slashed interest rates on Tuesday.

But news of the Fed rate cut failed to stave off declines in U.S. stock markets, with the Dow Jones Industrial Average falling 128.11 points, or 1.1 per cent, to 11,971.19. However, the Toronto Stock Exchange's main index rallied -- gaining 508.76 points, or 4.2 per cent, to 12,640.89, after suffering a 600-point loss the day before.

The Canadian dollar also got a boost from the rate cuts, closing at $97.27 cents US, up 46 basis points from Monday.

Before markets opened, the Fed announced an emergency rate cut of 75 basis points to 3.5 per cent. It also lowered the discount rate it charges on direct loans to banks by 75 basis points to four per cent.

Meanwhile, the Bank of Canada reduced its key lending rate 25 basis points to four per cent.

"Financial market conditions have deteriorated since October," the bank said in an accompanying statement, "leading to a tightening of credit conditions in industrial countries. Given this, and a deeper, more prolonged decline in the U.S. residential housing sector, the 2008 outlook for the U.S. economy is now significantly weaker" than forecast in October.

While the bank said it expects domestic demand to remain strong in Canada, it projects weaker growth in 2008 than previously forecast. It said it expects somewhat stronger growth in 2009. It has also slashed its inflation expectations, saying both core and total inflation should fall below 1.5 per cent by the middle of this year before returning to the two per cent target by the end of 2009.

"In line with this outlook, the bank has decided to lower the target for the overnight rate and further monetary stimulus is likely to be required in the near term to keep aggregate supply and demand in balance and to return inflation to target over the medium term."

The bank said it would flesh out these forecasts in Thursday's monetary policy report update.

The larger U.S. rate cut "is the first rate cut of this magnitude since Oct. 2, 1984, and the first inter-meeting cut to the Fed funds rate since Sept. 17, 2001 [just after 9/11]," said Eric Lascelles, chief economics and rates strategist for TD Securities.

"The magnitude of the action suggests that the Fed now treats both the economic and financial market conditions with a great deal of seriousness, and that the Fed was either well behind the curve or believes that the magnitude of the situation is the most serious in several decades."

The Bank of Canada move, one of the last by outgoing governor David Dodge, comes as a rout of global markets continued to dash value from stock values. The Nikkei stock average closed down 5.65 per cent and Hong Kong's Hang Seng index lost 8.65 per cent a day.

European markets recovered after falling more than 4.4 per cent, with the pan-European FTSEurofirst 300 index up 0.6 per cent at 1,287.92 points after the Fed's announcement.

(prepared by John Morrissy/Vancouver Sun)