Shares rise on cautious optimism after Fed injection

WASHINGTON/LONDON (Reuters) - A surprise injection of an extra $1 trillion into the U.S. economy by the Federal Reserve lifted stocks worldwide and revived hopes for an improvement in the global financial system.

The dollar suffered its biggest one-day drop since 1985 following Wednesday's Fed move, and oil and commodity prices revived as investors edged back into riskier markets. [nLJ361705]

"Whilst it is too early to say that the green shoots of recovery are here, the pendulum appears to be swinging back to half way," said Chris Hossain, senior sales manager at ODL Securities.

He and others cautioned that initial euphoria from the Fed move could soon peter out.

The dollar steadied on Thursday after sliding 3 percent after the Fed announced it would buy up to $300 billion of longer term U.S. government debt over the next six months in the first operation on such a scale since the 1960s.

The Fed also said it would expand an existing scheme to buy mortgage-related securities by another $850 billion, to $1.45 trillion this year, driving U.S. home mortgage rates toward record lows.

Few analysts had expected the U.S. to follow Japan and Britain in pumping money directly into the economy so soon.

World stocks, as measured by MSCI's all country index .MIWDOOOOOPUS climbed 1.69 percent to 200.71, while European shares .FTEU3 rose 0.65 percent.

Asian stock markets outside Japan rose to a five-week high after U.S. indices finished between 1.2 and 2.1 percent on Wednesday, although the dollar's weakness against the yen weighed on Japanese stocks, which dipped 0.3 percent.

The U.S. has led calls for Europe to top up current stimulus packages that have so far failed to reverse the downturn but European leaders meeting in Brussels on Thursday were expected to propose instead that April's G20 talks give the International Monetary Fund more firepower to tackle recession.

FIXING BANKS

Some economists said that even at such a hefty cost the Fed may not get what it was hoping for.

"Will the next trillion dollar injection gain any more traction? Probably not. Banks don't want to lend and borrowers don't want to borrow," said economists at DBS Bank in Singapore.

"The fact remains that expansionary policy at the bottom of a cycle is like pushing on a string," the bank's research team said in a note, stressing that fixing the ailing banks was necessary for recovery to take hold.

The Fed has also highlighted the importance of the $700 billion clean-up of the financial sector ravaged by investments in toxic debt linked to the U.S. mortgage market, whose meltdown sparked the global financial crisis.

Outrage over bonuses offered by insurer AIG, one of the main recipients of government aid, threatens to undermine the rescue at a time when President Barack Obama is likely to be seeking public support for more bailout money.

AIG Chief Executive Edward Liddy tried to appease angry lawmakers on Wednesday, saying he had asked employees to repay some of the bonus money.

The Fed's announcement came hours after the Bank of Japan boosted its government bond purchases plan for this year by nearly a third to 21.6 trillion yen ($225 billion) and days after the Bank of England started buying government bonds with newly created money to breathe life into the faltering British economy.

All three central banks have already pushed interest rates near to zero and are looking for unorthodox ways of getting funds flowing to companies and consumers to battle the worst global downturn since the 1930s Great Depression.

Of all major economies, Japan has been hit hardest by the collapse in global demand and trade.

A monthly Reuters survey of Japanese manufacturers confirmed the dire state of the world's No.2 economy on Thursday, with its sentiment gauge hitting a record low in March.

Japan's central bank said on Wednesday its debt purchases served to "smooth market operations." [nT8455]

Finance Minister Kaoru Yosano welcomed the central bank's decision, saying the moves would bring down long-term yields, making state and corporate borrowing cheaper.

"It will clearly curb a rise in long-term interest rates, having a favorable effect on rates not only on government debt but also on corporate bonds," Yosano told reporters on Thursday.

Prime Minister Taro Aso, faced with approval ratings near 10 percent and the worst recession since World War Two, is planning a third stimulus package that would require more borrowing from the most indebted government in the industrialized world.

(Reporting by Reuters bureaus worldwide; writing by Philippa Fletcher; editing by Matthew Jones)