Central bank calls shock interest rate cut

The Swiss National Bank said the global financial crisis was having a considerable impact on the economy Keystone

The Swiss National Bank (SNB) has joined forces with other central banks to slash interest rates in a desperate bid to revive the ailing financial markets.

Business leaders welcomed the 0.25 per cent cut in the key interest rate to 2.5 per cent. One economist said the SNB had lost control of interbank lending, which could have serious consequences for the economy.

The Swiss Market Index of the 20 leading companies reacted positively to the anouncement with a momentary 1.58 per cent increase but still closed down 5.51 per cent at 6073.45 points.

The surprise move represents the second coordinated attempt in two months by the world’s major national banks to revitalise the faltering credit markets.

In September, the SNB contributed $15 billion (SFr16.9 billion) to a $100 billion emergency injection of liquidity.

Switzerland joined the United States Federal Reserve, the European Central Bank, the Bank of England and the central banks of Canada and Sweden in cutting interest rates on Wednesday.

The reason for the joint venture was to encourage banks to start lending to one another again by providing cheaper lines of credit. The measure goes hand in hand with a plan by the US government to buy up bad debts that are at the heart of the current financial crisis.

Rudolf Minsch, chief economist at the Swiss Business Federation (economiesuisse), said companies had started to feel the effects of the credit crunch in the last few days when lending rates increased.

Christmas deadline

“There are some signs in Switzerland that it is getting difficult to get credit, particularly for small and medium-sized enterprises,” Minsch told swissinfo.

“If stability can be restored after Christmas we can survive. But it would be very serious if the credit crunch continued into 2009 and started to impact on the real economy.

“We think this is a good decision [to cut interest rates] at the right point in time. There was a need for a clear signal and this has given some reduction in uncertainty.”

The SNB had decided only last month to hold its key interest rate target at 2.75 per cent to curb inflation and was not due to meet again on the issue until December. But it said in a statement that its priorities had recently changed.

“The global financial crisis has intensified and is having a considerable impact on the international economy.

“The Swiss economy is also affected by these developments. In view of the improved inflation outlook… the SNB is now able to loosen its monetary policy reins,” the statement said.

The SNB added that it hoped the measure would bring down the Swiss franc three-month Libor (London Interbank Offered Rate) from its current range of 2.5-3 per cent to a target range of 2-3 per cent.

Great Depression

Libor sets the rate at which banks lend to one another, but the current turmoil in the financial markets has pushed this rate above three per cent in the last few days, making credit even more expensive.

Bank Sarasin chief economist Alessandro Bee said this could have drastic implications for the Swiss economy.

“In the last few days they have somehow lost control over the Libor rate which is a scary sign. In a downturn, monetary policy [controlling the supply of money and setting interest rates] is probably the only instrument that works,” he told swissinfo.

“If they don’t succeed in stabilising the financial markets we could see something worse than an average depression, it would be more like the Great Depression of the 1930s.”

swissinfo, Matthew Allen in Zurich

The credit crunch

The current turmoil in the financial world, precipitated by the collapse of the US subprime mortgage market, has resulted in fewer loans being offered between banks or to businesses.

The financial community is reluctant to lend because it is hard to determine how much debt individual institutions have on their books. This lack of transparency has increased fears that loans would not be paid back.

Financial institutions and businesses cannot function without an adequate supply of cash liquidity. So far, the financial crisis and the resulting credit crunch has mainly affected banks and insurance firms, but there are fears that companies could soon start to fail if they can no longer secure loans.

Central banks have responded by pumping more money into the system and now by reducing interest rates.

The US government also plans to buy up a large part of the bad debts held by the financial community in an effort to remove fears of loans going bad.

Libor

The Libor (London Interbank Offered Rate) is a key tool of the Swiss National Bank.

It designates the interest rates fixed every business day by the British Bankers’ Association.

These are the rates at which major banks are prepared to grant unsecured money market loans to each other.