Global stocks bounce, Iceland hikes rates massively

Reuters
Global stocks bounce, Iceland hikes rates massivelyTuesday October 28, 10:33 am ET By Burton Frierson and Elizabeth Piper

NEW YORK/LONDON (Reuters) - Global stocks roared back from five-year lows on Tuesday as investors cheered a thaw in credit markets while Iceland hiked interest rates massively in a desperate attempt to save its currency from the world's financial turmoil.

Investors expect major economies to cut rates, starting with the United States on Wednesday and Europe and Britain to follow next week, in an effort to head off a deep recession.

The Dow jumped 4 percent in early trading, coming on the heels of a world-wide rally that started in Japan, where stocks closed 6.4 percent higher -- but only after hitting a 26-year low. European shares were up nearly 4 percent.

Japan restricted investor bets on falling share prices to try to end its stock market slide, and its prime minister delayed calling a parliamentary election to concentrate on protecting the world's second biggest economy from recession.

The question for many, however, was how long this stock market recovery could last.

"There's nothing to suggest that that anything has changed radically," said Bernard McAlinden, investment strategist, at NCB Stockbrokers in Dublin. "It's not significant. The fundamental weakness is still there. We saw a recovery in an oversold market in Asia."

Closely watched rates on loans between banks eased, showing efforts by central banks to lower borrowing costs were making progress although a further reduction was needed to restore the financial system to normal functioning.

However, in a reminder that the current crisis has its origins in the bursting of the U.S. housing bubble, data showed prices of U.S. single-family homes plummeted a record 16.6 percent in August from a year earlier.

The data covers the period just before the worst of the recent credit and financial markets trauma took hold in September and October.

In a sign that the financial turmoil may undermining an already shaky economy, U.S. consumer confidence plunged to a record low in October, according the Conference Board's survey which dates to the 1960s.

BOLSTERING

Countries continued to bolster their banks, which have been hit by holding assets linked to bad mortgage debts in the United States, and shore up tumbling stock markets.

Tiny Iceland, a surprisingly high-profile victim of the global credit crisis, raised interest rates by massive 6 percentage points to 18 percent, taking the opposite tack to most countries fighting the global financial crisis.

Iceland's once-booming economy has been driven close to collapse by bank failures, and the central bank said the steep rate increase was part of a deal struck with the International Monetary Fund for a $2 billion loan.

The finance minister said the increase was also to stabilize the Icelandic crown, which has crumbled and effectively stopped trading on October 22.

"If we are successful, which I am confident in, this will only be for a short time that we need to act on the foreign currency rate with high interest rates," Arne Mathiesen said.

The move was a "desperate attempt to restore a degree of confidence in the local market," said Elisabeth Gruie, emerging markets strategist at BNP Paribas in London.

Prime Minister Geir Haarde said he was optimistic about getting $4 billion from other Nordic states, which Iceland judges it needs on top of the IMF money.

RATE CUTS ELSEWHERE

Governments have agreed to provide around $4 trillion to shore up banks and markets to ease the worst financial crisis in 80 years. The Bank of England said the efforts should calm the banking system but was cautious about the wider economy.

It projected losses globally at $2.8 trillion.

"The instability of the global financial system in recent weeks has been the most severe in living memory," said Deputy Governor John Gieve. "And with a global economic downturn under way, the financial system remains under strain."

Britain, the United States and European Central Bank are expected to cut rates to spur growth.

The consensus among Fed watchers is for a half-point cut in rates to 1 percent, the lowest level since June 2004. It has already cut the benchmark federal funds rate to 1.5 percent from 5.25 percent over the past 13 months.

It will announce its decision on Wednesday. The ECB and Bank of England are expected to cut rates on November 6. The moves would follow a coordinated round of monetary easing from major central banks earlier this month.

EU, IMF HELP

The IMF is due to finalize a deal this week with Hungary. Germany said it would help negotiations between the IMF and Pakistan, which has just a few weeks to raise billions of dollars in foreign loans needed to meet debt payments and pay for imports.

The EU commission said member states were agreed in principle on granting aid to Hungary, where the economy is heavily exposed to foreign financing at a time when investors are pulling back from developing economies.

Further afield, a senior official at South Korea's central bank said he expected a "broad second shock" in financial markets, especially in emerging economies.

He said South Korea and Brazil had faced the first wave.

South Korean banks turned to the U.S. Federal Reserve for dollars for the first time to help resolve a dollar funding crisis.

Faced with a funding squeeze and a sharp economic downturn, major companies joined banks in approaching the government for aid. U.S. automakers General Motors and Chrysler sought government cash for a merger.

Three of Japan's largest banks, which largely escaped the fallout from U.S. mortgage defaults, are nonetheless looking to replenish capital lost on the tumbling stock market.

Tokyo banned naked short selling, bringing the move forward by one week. Naked short selling allows traders to effectively sell stocks they do not own and without borrowing them first in the hope they will profit by buying stocks back at a lower price.

(Reporting by bureaus in Europe, Asia and the Americas; Editing by Tom Hals)