Shares surged on both sides of the Atlantic yesterday in a dramatic rebound after the US Federal Reserve moved to soothe investors’ frayed nerves with a surprise intervention to ease the worldwide squeeze on credit markets.

In unexpected action that saw the Fed step up a gear in its efforts to stem global market turmoil, the US central bank cut its discount rate, governing the cost of its direct loans to banks, as it sought to prevent the seizing up of US commercial lending markets. The half-point cut, to 5.75 per cent, did not affect the central bank’s benchmark Fed Funds rate, which steers the US economy, and was mainly symbolic.

But the sudden lift to the spirits of investors shell-shocked by the vicious market conditions of the past month was enough to send shares soaring in New York, London and across Europe.

Market morale was given an even stronger boost by the Fed’s statement, which gave a clear signal that its policy-making Open Market Committee (FOMC) now stands ready to cut mainstream official interest rates to stabilise markets and safeguard the US economy should this be necessary.

Opening the door to a rate cut, which some economists said could even come as an emergency move within days if greater market calm fails to materialise, the Fed said: “Downside risks to the growth have increased appreciably . . . The Fed is monitoring the situation and is prepared to act as needed to mitigate the adverse effects on the economy arising from the disruptions in the financial markets.”

In the wake of the Fed’s action, blue-chip shares in leading markets charged higher. The New York Stock Exchange was even forced to impose trading curbs as the Dow Jones industrial average leapt by more than 320 points at one stage. The Dow later closed up 233.3, or 1.8 per cent, at 13,079.1. The broader-based S&P 500 index was ahead by 2.4 per cent.

In London, the FTSE 100 index was propelled upwards by 205.3 points by the close, largely erasing Thursday’s severe losses, the worst for 4½ years, to end the week in positive territory, at 6,064.2. Yesterday’s 3.5 per cent advance by the FTSE marked its sharpest one-day percentage rise since March 13, 2003. Markets also soared across Europe, with Germany’s Dax index adding 1.5 per cent and France’s CAC 40 up 1.9 per cent.

The Fed said that its discount rate reduction was designed “to promote the restoration of orderly conditions in financial markets”. Economists noted, though, that this step should mainly be seen as a move to reassure nerve-racked investors and signal the Fed’s readiness to do still more.

Since market interest rates are already markedly below the discount rate’s present level, it would be of practical use only to banks with no other recourse. Analysts also sounded warnings that some market players could see the Fed’s decision negatively. “Investors could start interpreting it as a sign that the Fed knows something about possible losses in the banking system,” Julian Jessop, of Capital Economics, in London, said.

It later emerged that the Fed had convened a highly unusual teleconfer-ence with leading US banks to discuss yesterday’s action and encourage them to make use of the discount rate facility without fear of being tainted as harbouring bad loans.

In currency markets, the dollar fell back, halting a week-long rally in which traders have piled capital into the safe havens of the greenback and US Treasury bonds. Treasury bond prices rose, pushing yields higher, as markets moved to price-in greatly increased chances of an early cut in the Fed Funds interest rate.

While the European Central Bank is not expected to follow the Fed, a key member of its governing council, Axel Weber, the President of the Bundes-bank, hinted that a widely predicted rise next month may not now take place.

“We have our finger on the pulse of financial markets,” he said. “Financial stability is one of our tasks [and] we will fulfil all our responsibilities.”

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