Asian and European stocks tracked Wall Street lower and the dollar slipped on Wednesday after the Federal Reserve's interest rate cut disappointed investors hoping for more aggressive action.
The Fed cut benchmark interest rates by a quarter percentage point to 4.25 percent on Tuesday, confounding investors who had expected a bolder half point move to help to cushion the U.S. economy from the subprime mortgage crisis and tight lending conditions.
It cut the discount rate -- at which banks borrow from the Fed -- by a matching 25 basis points, also letting down those who had expected a deeper cut to help financial institutions shore up their balance sheets by the year end.
Some participants were expecting a bigger cut than 25 bps and some were also expecting a more aggressive decision on the discount rate. So ... that's somewhat disappointing, said Carole Laulhere, currency strategist at Societe Generale in Paris.
Clearly the major risk is that the Fed is forced to cut rates once again ... The other opportunity will be that the Fed may cut the discount rate more aggressively, and another possibility will be for the Fed to inject more liquidity.
The FTSEurofirst 300 index was down 1 percent while MSCI main world equity index was down 0.6 percent. Wall Street fell more than 2 percent on Tuesday.
The dollar was down around 0.3 percent against the euro and sterling, while it gained 0.6 percent against the low-yielding yen.
High-yielding currencies such as the Australian and New Zealand dollar rose 1 percent against the greenback in a sign that investor risk appetite in the foreign exchange market is holding up.
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Few people believe that the Fed has finished loosening monetary policy. A majority of Wall Street dealers, polled by Reuters, expect the bank to lower interest rates in January. Some expect even more aggressive action.
By practically doing the least amount realistically possible, the Fed may well have put itself into a position where it may have to do the unthinkable and cut rates again inter-meeting, David Rosenberg, North American economist at Merrill Lynch, said in a note to clients.
We're not even sure the Fed fully acknowledges how fast the economy is decelerating. It notes that 'economic growth is slowing' when it is actually vanishing.
A Fed source told Reuters late on Tuesday that the central bank is actively considering all of the tools it has available to address liquidity issues.
Newspaper reports said action could come as early as Wednesday. The Financial Times web site said an overhaul was likely to take the shape of a new liquidity facility that will auction loans to banks.
It said this would allow the Fed to provide liquidity directly to a large number of financial institutions against a wide range of collateral without the stigma of its existing discount window loans.
Liquidity shortage has been a problem in the financial sector as banks hoard cash as a contingency against credit-related losses.
Analysts say, however, there is sufficient liquidity in the world economy in general, partly as emerging markets enjoy large current account surpluses. Even in the euro zone where interbank lending is drying up, money supply growth is at record highs.
Central banks in Europe and the United States also face growing inflation risks from high energy and food prices, which limit the options of aggressively cutting rates.
Emerging sovereign spreads widened 1 percent while emerging stocks were down more than 1 percent.
The March Bund future was steady.
U.S. light crude fell 0.5 percent to $89.58 a barrel as the Fed's modest rate cut was seen weighing on demand. Gold fell to $803.40 an ounce.
(Reporting by Natsuko Waki; editing by David Stamp)