inancial markets were, however, left totally underwhelmed by the announcement. US equity markets staged a small rally yesterday, although only a very minimal one – the Dow Jones and S&P 500 indices remain around 8% lower since mid-February. The reaction in the FX market was also pretty limited following a modest knee-jerk move. The dollar actually appreciated yesterday, ending London trading roughly where it was before the Fed’s surprise announcement.

But what was behind the lack of reaction in the market?

1) Rate cut can do nothing to stop the spread of a disease, only soften the economic impact.
2) Lower interest rates cannot affect the supply-side shock caused by the virus.
3) ‘Emergency’ cut headlines may spook the average consumer. It is conceivable that the Fed’s unscheduled move may create panic among US consumers and have the opposite impact on domestic demand than intended.

The overriding view in the markets is that the Fed’s big cut was a bit of a damp squib. While policy easing can go a long way to softening the economic blow, it will not make the problem go away any time soon.

BoC slashes rates, other G10 banks to follow

We noted in our special report following the Fed’s rate cut that other central banks would be shortly following suit. This is exactly what we got yesterday, with the Bank of Canada announcing its own 0.5% rate reduction, taking its main policy rate from 1.75% to 1.25%.

Similarly to the Fed, the BoC warned over the risks posed by the virus, stating that lower rates were needed in order to partially offset the knock-on impact on consumer confidence and financial conditions. Governor Poloz also noted that the bank was ready to do more, which we think effectively tees up another rate cut at its next meeting in April.

The next major central bank meeting on the docket is next Thursday’s ECB meeting. Our view is that a 10 basis point rate cut here is highly likely, with an increase in the bank’s QE programme and increased loans to Euro Area banks also a possibility. The bank does, however, have very little room for manoeuver, which should continue to be positive for the euro.

Sterling rallies despite rampant rate cut bets

The pound, meanwhile, ended sharply higher for the day, opening the London trading session this morning around the 1.29 mark versus the dollar.

There were rumours floating around that the Bank of England could follow the Federal Reserve in announcing a pre-emptive rate cut on Wednesday, so the fact that they didn’t may have been behind some of the strength in sterling. Incoming governor of the BoE Andrew Bailey spoke yesterday, saying ‘it is quite reasonable to expect we are going to have to provide – collectively going to have to provide – some form of supply-chain finance in the not-very-distant future’.

Similarly to some of its major counterparts, the Fed, RBA and BoC, we think that market pressure is so high on the BoE that they may have no alternative but to cut rates on or before the next policy meeting, scheduled for 26th March. The real question will be, whether or not this will be a standard 25 basis point cut, or a more substantial 50 bp rate reduction.