Recession fears deepen, rate cuts on horizon

NEW YORK Wed Dec 3, 2008 4:29pm EST

1 of 16. Trading specialists work on the floor of the New York Stock Exchange, December 3, 2008.

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NEW YORK (Reuters) - Record declines in the vast U.S. and European service sectors and more grim U.S. employment news on Wednesday sparked fear of an economic "free fall," setting up another round of aggressive interest rate cuts.

Central banks in Thailand and New Zealand led the way, rolling back borrowing costs sharply. Britain, the eurozone and Sweden were expected to follow suit on Thursday as worries about a prolonged global recession set in.

U.S. stocks rallied, though, as recession fears boosted consumer staples and other defensive shares, while a late rally lifted the FTSEurofirst 300 index of European shares by 0.5 percent, capping off a roller-coaster session.

Reports showing the U.S. service sector, the main engine of economic growth, fell to a record low while private employers shed 250,000 jobs in November -- the most in seven years -- also boosted chances the Federal Reserve will cut interest rates later this month.

The jobs data from ADP Employer Services also suggested Friday's more comprehensive government report could show job losses in excess of 300,000, which would be the highest since the aftermath of the September 11, 2001 attacks.

"The fourth quarter of 2008 is experiencing an economic free fall," said Richard DeKaser, chief economist at National City Corp in Cleveland. "We haven't had this kind of a collapse in a very long time."

A snapshot of U.S. business conditions released by the Fed on Wednesday showed activity weakened across the country in October as job layoffs picked up and retail sales slumped.

It came two days after a private research group considered the official arbiter of business cycles said the U.S. economy entered recession in December 2007. Economists forecast it would likely stay there through the middle of 2009, which would make it the longest recession since the 1930s.

The diagnosis elsewhere was hardly better. The Markit Eurozone Purchasing Managers Index for services firms, which covers businesses ranging from banks to bars in the euro zone, plunged to its lowest level in the survey's 10-year history.

A key global reading of services and manufacturing activity also fell to a record low last month, while a UK survey showed the country's dominant services sector shrank last month at its fastest pace since the data series began in 1996.

GLOBAL INTEREST RATES HEADING LOWER

The data added to the pressure on both the Bank of England and European Central Bank to reduce interest rates sharply this week as both economies sink deeper into recession.

"There is ample room for the ECB to cut rates. We think 75 basis points will be the compromise, but we would not rule out a cut by 100 basis points," said Juergen Michels at Citigroup.

The Bank of Thailand on Wednesday cut its main interest rate by 100 basis points to 2.75 percent, the biggest reduction in eight years, to help the economy cope with a global credit crisis and political unrest. It was its first cut in 16 months.

New Zealand also slashed its official cash rate by 150 basis points, to 5 percent, the fourth cut since July, and said expansionary policy was needed to combat a slowing economy.

Australia cut rates by a full percentage point earlier this week, a move economists expect Britain to match on Thursday. Sweden's Riksbank is seen cutting rates by a quarter point.

In addition to lower rates, British Prime Minister Gordon Brown said he would focus on easing the pain of the looming recession with laws to protect savers and prevent banks suffering funding crises.

In a legislative program set out in the traditional speech to Parliament by the Queen, Brown's government outlined plans to give the Bank of England powers to step in as soon as a bank begins to show signs of financial trouble. It also pledged more protection for bank depositors.

"The strength of the financial sector is vital to the future vibrancy of the economy," the Queen said in the speech.

CHINA COOL ON AID

President-elect Barack Obama said Wednesday he was looking at whether taxpayers are getting maximum bang for their buck from a $700 billion financial rescue package and called for helping homeowners avoid foreclosure.

The U.S. Treasury Department is considering a plan to halt sliding home prices by lowering mortgage rates through home-finance powerhouses Fannie Mae and Freddie Mac, the Wall Street Journal reported on Wednesday.

It also said Treasury Secretary Henry Paulson, who was on his way to Beijing for talks with Chinese officials, may ask Congress next week for the second half of the $700 billion government rescue.

Paulson may not receive any promises of further investment in China, particularly from China's sovereign wealth fund, whose chairman said he was "not brave enough" to invest in foreign financial firms amid a shifting regulatory terrain.

"It's changing every week. How can I be confident?," China investment Corp Chairman Lou Jiwei said in Hong Kong.

The Chinese government said it would make use of required reserves as well as interest rates and the exchange rate to ensure ample liquidity in the country's banking system.

The Chinese State Council also approved measures aimed at stabilizing the battered domestic stock market, boosting bond issuance and increasing the supply of credit.

Elsewhere, U.S. automakers prepared to plead the case to Congress that they have a viable future. Ford Motor Co wants a $9 billion credit line. General Motors Corp asked the U.S. government to save it from failure by extending $12 billion in loans and another $6 billion in a credit line.

U.S. politicians worry that without government aid, the companies could collapse and millions of jobs would be lost.

Obama said on Wednesday the Big Three had put forward "a more serious" restructuring plan but withheld further judgment until after congressional hearings.

In Seoul, the Bank of Korea discussed buying more bonds from banks hit hard by the credit crunch and easing rules on how much cash they must keep in reserve.

(Additional reporting by Reuters bureaus worldwide; Editing by Dan Grebler)

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