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China joins effort to spur growth

Decisions by three of world's five key banks the most dramatic dose of collective action since the financial crisis

00:00 EDT Friday, July 06, 2012

WASHINGTON -- An economic slowdown is causing alarm in China and Europe, forcing central banks in both regions to cut borrowing rates.

The People's Bank of China dropped its main lending rate to 6 per cent from 6.31 per cent on Thursday, surprising investors because Governor Zhou Xiaochuan had cut interest rates only a month earlier. In Frankfurt, the European Central Bank reduced its benchmark rate by a quarter of a percentage point to 0.75 per cent, the lowest in the history of the euro zone. The Bank of England also took measures to inject money into the financial system to give a lift to the flagging U.K. economy.

While the European moves were anticipated, the unexpected addition of China introduced a sense of drama, as together, the three decisions represented the most dramatic dose of collective action by central banks since the financial crisis of 2008-09

"There seems to be some kind of co-ordination going on" among policy makers, said Daniel Bain, chief investment officer at Toronto-based Thornmark Asset Management Inc., which oversees investments worth $500-million. "That co-ordination is required because the global economic fundamentals are weak."

While Europe's economy has been struggling for some time, it is China that is causing much of the concern lately. After leading the world economy out of the recession in 2009, the world's second-largest economy is struggling to generate enough domestic demand to make up for diminished exports to Europe, where growth has all but stalled because of the region's sovereign debt crisis.

Two weeks ago, the Federal Reserve also took action, extending a stimulus measure that was set to expire; Chairman Ben Bernanke said the U.S. central bank was prepared to do more if the job picture failed to improve.

The U.S. unemployment rate is 8.2 per cent, compared with 5 per cent at the start of 2008, and is not expected to change much when the latest data on the labour force are released today.

A deteriorating global economy could force the Bank of Canada to further delay its plans to raise its benchmark lending rate back to a more typical level. Earlier this week, economists at BMO Nesbitt Burns in Toronto said they don't expect the bank to raise short-term rates until July 2013; previously, they had expected a rate hike in January.

As long as U.S. rates stay low, the Bank of Canada's room to manoeuvre is limited because significantly higher interest rates in Canada would put upward pressure on the Canadian dollar. At a time when global trade is weak, a stronger currency would represent an additional blow to Canadian exporters.

It's unclear whether the measures announced Thursday will have much impact. Equity markets were little changed, a signal that investors were either spooked that the global economy is deteriorating, or doubtful of policy makers' ability to turn things around.

China could be in a new phase of reducing borrowing costs, after spending much of last year making money more expensive in order to deflate a real-estate bubble.

Anything that encourages China's middle class to spend will be good for the global economy in the short term, although the country's recent slowdown in growth suggests its consumers are a long way from spending like Europeans and North Americans.

The ECB's benchmark interest rate now is lower than it was during the financial crisis. The central bank also said it would stop paying interest on the money private lenders stash at the ECB, a measure meant to encourage banks to take some risks by lending more to consumers and businesses.

Yet some analysts said the ECB was too timid, and could have cut its key rate by half a percentage point to 0.5 per cent. Many observers of the situation in Europe, including Mr. Bain, say the central bank must commit to buying the debt of countries such as Italy and Spain to keep borrowing costs in these countries under control.

Only then will such economies have the breathing room necessary to grow, Mr. Bain said.

ECB president Mario Draghi conceded that one the biggest issues in Europe is that there is little demand for loans, no matter the price.

Yet he argued the ECB's latest measures would have an important psychological effect by boosting confidence.

© The Globe and Mail

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