Following the lead of the U.S. Federal Reserve, both the Bank of England and the European Central Bank announced an interest rate cut of 50-basis points this today, bringing the British repo rate to 4.00% and the Euro-zone refi rate to 3.25%.

Although both banks were generally expected to cut rates, markets were surprised by the size of the cuts, notes Bank of Montreal. The cuts were expected to be 25 bps.

In its press conference after the meeting, ECB President Wim Duisenberg indicated that improved inflation prospects in the medium-term in light of weaker economic activity prompted the decision to move rates lower, says BMO.

He also commented that Euro-zone growth would remain weak in the second half of this year and below potential through early 2002 as weak global demand dampened Euro-zone exports, it reports.

“The underlying reasons behind this rate cut are pretty obvious: the Eurozone manufacturing sector is in recession and the latest economic indicators are pointing to even worse times to come. This recessionary manufacturing sector is having an extremely negative effect upon employment and we are now getting the first evidence that the deteriorating labour market is starting to impact the consumer sector,” says CIBC World Markets. “Today’s rate decision is therefore totally justified from a fundamental perspective, but this has been the case for a long time now.”

BMO says that the Bank of England indicated its rate cut reflected the view that the global slowdown appeared to be deeper and longer than previously thought. It concluded that in this environment, inflation would fall below the target without a rate cut.

“The Bank’s decision to cut by as much as 50 bps is a surprise in a sense that on September 18, when conditions were much more dramatic and when all other central banks delivered a more aggressive 50 bps cut, the MPC stuck to a 25 bps move. So why become more aggressive today?” asks CIBC.

“Anyway, this more aggressive move will not harm the economy at a time when the manufacturing sector remains deep in recession and as there are mounting signs of weakness in the service sector.”