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Europe turns on funding taps to ease crunch

The European Central Bank and Bank of England flooded money markets with funds on Tuesday as the UK central bank chief warned of a possible “self-reinforcing” downward spiral in credit.
/ Source: Reuters

The European Central Bank and Bank of England flooded money markets with funds on Tuesday as the UK central bank chief warned of a possible “self-reinforcing” downward spiral in credit.

The Bank of England (BoE) charged a minimum bid rate of 5.36 percent for its offer of 10 billion pounds of 3-month money, as part of a coordinated action with other central banks to ease market tensions by offering cash at favorable rates.

The money was taken up though demand was muted. Previous similar auctions had failed as the BoE had set a minimum rate way above the main lending rate and no bank wanted to be seen as desperate for cash.

“In the last four weeks, banks themselves have been worried that the impact of their reluctance to lend will lead to a sharper slowdown in the United States,” Bank of England Governor Mervyn King told a parliamentary committee.

“That concern is a serious one because it does hold out the prospect that there will be a self-reinforcing downturn in credit and activity.”

The ECB scrapped the usual upper limit on how much it lends to banks in Tuesday’s refinancing operation, offering two-week money to ensure lending rates stayed close to its target of 4 percent.

Banks clambered in, bidding for a hefty 348.6 billion euros ($500 billion) at a 4.21 percent lowest rate. Two-week Euribor interbank rates fixed sharply lower in response.

The offer was the first time the ECB has said it would meet all banks’ refinancing bids above a certain rate since its first liquidity injection on August 9, as the credit crunch blew up.

“They’re throwing everything they can at the liquidity problem,” said one trader.

On Monday, the ECB offered $20 billion of 28-day funds at auction as part of the joint plan by leading central banks to alleviate strains in the interbank lending market.

The Federal Reserve offered a similar amount, while the Swiss National Bank (SNB) offered up to $4 billion at a discount to the Fed’s existing discount rate.

Results of those auctions are due on Wednesday.

Most experts say the joint action, whereby the Fed, SNB, ECB, BoE, Bank of Canada and others provide fresh short-term lending, is unlikely to solve the crisis alone.

U.S. subprime mortgages — lent to people ill-equipped to pay them back — were bundled up into complex financial products and sold on around the globe.

Only when uncertainty has been resolved as to where the exposure lies are commercial banks likely to lend money freely to each other again on the interbank market, which oils the global economy’s wheels.

“Large banks are now awash with cash. The issue is not whether they have enough cash, it is whether they are inclined to lend,” King said.