Fears abate but still linger post-Fed

 @ibtimes
on August 20 2007 9:32 AM

Policymakers and investors breathed a sigh of relief on Monday as Federal Reserve action brought calm to shaken financial markets, but experts said it was too soon to discount a global credit crisis.

As shares climbed, French Economy Minister Christine Lagarde said she believed the worst of the credit turmoil had passed, although some funds could still hit trouble.

I think the worst of the crisis is behind us. I don't exclude that, particularly in America, a number of funds could find themselves in difficulty but this is a classic phenomenon of American finance which is often guilty of excess, she told BFM radio.

The Bundesbank said the outlook for the global economy remained positive despite recent market tension, which represented a welcome normalization, albeit an abrupt one.

Nevertheless, the risks for the global economy have increased with the correction process in the U.S. property market, the German central bank said in its monthly report.

Asian stock markets rallied strongly after the Federal Reserve cut the discount rate that governs direct loans to U.S. banks on Friday by a hefty half point to 5.75 percent.

Japan's Nikkei average (.N225: Quote, Profile, Research) climbed 3.0 percent on Monday, its biggest daily gain in 13 months, bouncing from its biggest one-day fall in nearly six years on Friday.

European shares followed suit with the FTSEurofirst 300 index (.FTEU3: Quote, Profile, Research) of leading European shares gaining 0.7 percent.

A credit crisis has snowballed in recent weeks as defaults on risky U.S. subprime mortgages hit banks across the globe, fuelling fears of financial instability and a credit squeeze, and prompting central banks to pour cash into money markets.

A European Commission spokeswoman welcomed the apparent calming of market turbulence after the Fed's intervention.

STILL ON ALERT

Central banks remained on alert on Monday.

In the wake of the market turmoil, investors have sharply altered their forecasts for monetary policy. They now expect the Fed to cut its key fed funds target rate and are no longer pricing in rate increases from the Bank of England.

Australia's central bank again injected a sizable amount of liquidity into the banking system, seeking to temper upward pressure on some short-term money market rates.

The euro zone overnight money market was calm, with traders awaiting a European Central Bank announcement expected around 1330 GMT about its weekly refinancing tender.

Few investors are confident that all the troubles stemming from the U.S. home loan market have yet seen the light of day and fear that further market turmoil would cut economic growth.

The Fed's move has given everyone a psychological boost. It's a short-term thing, though. It doesn't deal with the longer-term issues, the underlying problem from the decelerating housing sector in the United States, said Song Seng Wun, economist and head of research at CIMB in Singapore.

Underscoring that caution, Sentinel Management Group Inc, a cash management firm serving the U.S. futures industry, filed for Chapter 11 bankruptcy protection on Friday.

Also a group of German state banks moved to bail out a local German lender -- SachsenLB -- which had been hit by U.S. subprime mortgage difficulties.

LOWER RATES?

The European Central Bank is still likely to raise rates next month but may stop there. Monetary policy is still tending towards being expansively orientated, the Bundesbank said.

The Bank of Japan now seems unlikely to tighten at this week's meeting. Until recent days, a quarter-point increase to 0.75 percent had been widely expected.

Stocks and currency markets have been volatile due to the U.S. subprime mortgage problems, so I would like the BOJ to keep overall market movements in mind, Japanese Vice Finance Minister Hiroki Tsuda told a news conference.

More than half of U.S. primary dealer banks polled by Reuters now predict the Federal Open Market Committee will lower its key fed funds rate at its September 18 meeting, or even before.

Others, notably Bank of England Governor Mervyn King, say it is not the job of monetary policy to bail out poor investments unless they threaten the broader economy.

History shows that cutting rates at times of market turmoil can have lasting consequences.

The Fed cut rates after U.S. hedge fund LTCM came close to collapse in 1998 and stock markets were soon soaring into the dotcom bubble. UK rate cuts after the 1987 stock market crash were quickly reversed as the economy hit an uncontrolled boom.

(With additional reporting by Kerstin Gehmlich in Paris, Paul Carrel in Frankfurt, Umesh Desai in Hong Kong and Tetsushi Kajimoto in Tokyo)

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