A year ago, many economists and traders believed the US financial crisis would stay within the boarders of the world’s largest economy and other countries would be immune to the economic consequences. However, today’s side-by-side Bank of England and European Central Bank rate decisions have certainly banished any lingering skepticism that Europe was feeling the pinch of a broad recession and ongoing difficulty in the financial and credit markets. With a 150 basis points (bp) rate cut from the BoE, 50bps easing from the ECB and an unscheduled 50bp cut from the Swiss National Bank, European policy officials are trying to get ahead of the curve and quickly bring themselves in line with the aggressive action of the Federal Reserve.

A Coordinated European Rate Cut

Bank of England – At 7:00 ET on Thursday, the Bank of England (BOE) unexpectedly slashed rates by 150 basis points to bring the UK Bank Rate down to 3.00 percent, the lowest level since 1955. Indeed, a Bloomberg News poll of economists had only forecasted a 50 basis point reduction, making this move all the more shocking. Looking at the BOE Monetary Policy Committee’s (MPC) commentary released post-announcement, it is clear that the MPC is extremely concerned about not only the instability in the financial markets and persistently tight credit conditions, but also the significant downside risks to growth and perhaps most importantly, the risk that inflation will fall below their 2.0 percent target. The latest CPI figures show inflation growth at 5.2 percent in October, but given the economic slowdown and drop in commodity prices, the BOE has suggested that CPI will plummet in coming months. This echoes the rhetoric of the BOE’s most ardent dove, MPC member David Blanchflower, who said last week that deflation was a bigger concern than inflation, and that rates must be lowered “significantly” and “quickly.”

Swiss National Bank – Just one minute after the BOE cut rates on Thursday, the Swiss National Bank (SNB) surprisingly came in with a 50 basis point reduction to their 3-month LIBOR target rate, bringing it down to a nearly 2-year low of 2.00 percent. Since the SNB had not been scheduled to meet again until December, their rate cut indicates that this was part of a coordinated effort with the other European central banks. In a press release following the rate decision, the SNB said that they adjusted monetary policy in light of the worse-than-expected deterioration of the global economic outlook and lower inflation forecasts, given the drop in oil and appreciation of the Swiss franc. Their discussion of the currency, which they will “keep a close watch on”, suggests that they are somewhat concerned about its ascent and if these moves continue, may signal potential for a coordinated currency intervention on low-yielding currencies in coming months.

European Central Bank – At 7:45 ET on Thursday, the European Central Bank (ECB) cut rates in line with expectations by 50 basis points to a nearly 2-year low of 3.25 percent. As usual, comments by ECB President Jean-Claude Trichet during his 8:30 ET provided greater insight on where the central bank stands. Mr. Trichet said that the outlook for price stability has improved as inflation is anticipated to continue falling, though he could not rule out a sharp decline next year, suggesting that even they – previously one of the most hawkish central banks in the developed world - are concerned about the potential for deflation. Mr. Trichet also said that the rate decision was unanimous, a 75 basis point reduction was considered, and that he would not exclude cutting rates again. This seems increasingly possible, as the ECB noted that economic indicators had reflected slowing growth in the Euro-zone while downside risks from financial market tensions had materialized and remain a threat to expansion going forward.

The Fundamental And Technical Impact

Bank of England – The dramatic rate cut from the MPC was the biggest fundamental shift of the three European policy announcements; but the reaction from the currency market wasn’t exactly straightforward. Against a far more modest forecast of a 50bps rate cut, the 1.50 percentage point gash would be considered a significant damper for yield seekers under normal market conditions. However, these are far from normal conditions. Risk aversion is now holding a greater position in the market than appetite for return; and this has put a premium on those currencies that will find themselves ahead of the curve in their monetary policy regimes on the belief that those economies that can recover first will be in a better position to accept capital flows and see their rates rise more quickly. With such a hearty drop in its benchmark lending rate, the BoE has quickly moved the UK up the recession curve; and this is the reason for the pound’s ultimate advance over the dollar, euro, yen, and franc. However, yield differentials are still playing a role in the market; and the aggressive moves of the RBA and RBNZ have helped the Australian and New Zealand dollars to keep their buoyancy against sterling.

European Central Bank – Until today, the European Central Bank was the only G10 policy authority that was holding strictly to its inflation convictions. This stubborn stance was a boon for the euro for some time, helping to prop the currency against its major counterparts for some time. However, with the Euro Zone falling into recession and European banks requiring bailouts, speculation had gotten the best of the buoyant currency and turned its good fortunes. Today’s 50bps cut changed the ECB’s policy stance more than their participation in the coordinated rate cut at the beginning of October; because it reflected a change in their expectations for the worst and suggested they would act on rates outside of the influence of a financial panic. With such fundamental capitulation, the euro would drop against all its major counterparts.

Swiss National Bank – Usually, the SNB has the luxury of taking its time in delivering its monetary policy as the three central bankers meet regularly on a quarterly basis. However, the policy authority does stipulate that it can meet anytime to discuss the benchmark lending rate and this has instilled a sense of surprise with unscheduled rate shifts. Though the Swiss announcement comes in the guise of a coordinated European action, its 50 basis point cut still comes as a surprise. As Switzerland’s future is inextricably linked to the health of the Euro Zone, the ECB’s action had more of an impact on the outlook for economic activity going forward. For the franc, the SNB cut seems to have altered its place in the carry trade totem pole. Already an established funding currency for the strategy (for its low benchmark and stability of rates), the easing suggests the policy group will follow suit with the global decline in interest rates and the franc will continue to be a funding currency when risk aversion eventually dries up. With this shift, the franc sold off against most of its counterparts as risk aversion and carry unwinding have been curbed over the past few weeks.

John Kicklighter a Currency Strategist at FXCM.