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Fed Flummox

DW staff (jc)December 17, 2008

For some it was the right thing at the right time; for others the end of the financial world as we know it. The US Federal Reserve's decision to slash interest rates to near zero has Europeans scratching their heads.

Euro coins and a one dollar note
The dollar has plunged against against the euroImage: AP

The most immediate and unambiguous reaction on Wednesday, Dec. 17, to the Fed's decision came on currency markets. As the European business day closed, the euro was up by more than 3 cents, or 2 percent, against the dollar.

The US decision to reduce the prime rate to between 0 and 0.2 percent is a double-edged sword for Europeans. If the move increases American consumer demand and stimulates the global economy, it could help Europe's struggling industries.

But a weak dollar could also make it even harder for Europe's exporting nations, led by Germany, to sell their products on the world's biggest market.

"The economy…is stuck in heavy recession and can hardly cope with the additional burden on its competitiveness cause by rising exchange rates," wrote the daily German business newspaper Handelsblatt.

But German labor greeted the Fed's Tuesday decision and said Europe -- where the rate is currently 2.5 percent -- needed to follow suit.

"We hope that the European Central Bank will also shake itself awake and reduce interest rates by a further half of a percentage point," the chairman of the German Association of Unions, Claus Matecki, told Reuters news agency.

Uncharted territory

Federal Reserve Chairman Ben Bernanke
Fed Chairman Ben Barnanke's reputation could ride on this decisionImage: AP

Economists held likewise mixed opinions over the Federal Reserve's move to reduce interest rates to the lowest point in the institution's 95-year history.

"It's the right decision in light of the rapid fall in economic output," said the chief economist at Deutsche Bank, Norbert Walter. "But you shouldn't expect immediate results -- as always it will probably be a year before it has an effect on the economy."

But other analysts weren't so sanguine.

"The Federal Reserve has used up its ammunition," said Michael Heise, Chief Economist at the Allianz bank. "Now, we have to hope it works."

And others saw the move as a sign that the Fed was acting in desperation and abandoning decades of conventional economic wisdom.

"Ultimately, it means the Fed is pursuing monetary policy via printing more currency," Bernd Weidensteiner, an America expert at the Commerzbank, told dpa news agency. "Reducing the prime interest rate has become blunt instrument."

Switzerland's leading daily newspaper, the Neue Zuercher Zeitung, concurred.

"The Fed's leadership is like a computer administrator who, growing ever more impatient and frustrated, starts sending stronger and stronger jolts of power through the system -- even though some of the wires have already melted."

Investors not impressed

The German stock exchange
The DAX reacted to the Fed's decision with another glum shrugImage: AP

The Fed's decision sent share prices on Wall Street higher on Tuesday, after the move became known. But European investors didn't share that optimism.

Two of Europe's largest markets -- Germany's DAX and France's CAC 40 -- were recording slight losses in late-afternoon trading. In Germany, banking shares were among the day's biggest losers.

The Dow Jones also got off to a bad start on Wednesday as investors reacted to more bad news, including record losses by investment giant Morgan Stanley and uncertainty about the scope of the fallout from the alleged Madoff pyramid scheme.

And further doom and gloom from Europe could be on the horizon.

"It's being speculated that Deutsche Bank could soon announce serious losses," Reuters quoted an unnamed trader as saying. "This rumor is being passed along on the market."

Deutsche Bank shares were down as much as 9 percent during the course of Wednesday.