Central banks continue market intervention but at reduced levels


Central Banks Extend Liquidity Provisions

By Chris Flood
Financial Times, London
Monday, August 13, 2007


Central banks continued their battle to restore normal trading conditions to the global money market by injecting emergency liquidity for a third consecutive trading session on Monday.

"The fact that the central banks' injections of short-term liquidity into the markets appeared to be concerted has boosted equity investors' confidence that the monetary authorities have the will and the means to contain the fall-out from the US subprime mortgage debacle," said Stephen Lewis, strategist at Insinger de Beaufort.

The European Central Bank, US Federal Reserve, Bank of Japan, and the Bank of Canada all intervened again on Monday after last week's severe turbulence which brought global markets to the brink of a liquidity crisis as losses related to the US subprime mortgage market paralysed interbank lending and caused sharp falls across global equity markets.

Although central banks have continued to provide emergency liquidity, they have done so in progressively smaller amounts, signalling that they believe market conditions are normalising.

The European Central Bank injected E47.67 billion into the eurozone money markets on Monday, effectively a net drain of E13.39 billion in cash.

The operation on Monday replaced the E61.05 billion which the ECB provided to money markets on Friday, via a variable rate tender.

The ECB's first intervention came on Thursday when it offered an uncapped fixed rate overnight tender at 4 per cent that injected E95 billion into the market.

By moving to a variable rate tender on Friday from the Thursday's fixed rate tender, the ECB was trying to get a better picture of the severity of the situation in the interbank market, both through the maximum bid rate and the size of the bids at different rates.

The ECB has "injected massive amounts of liquidity to stabilise the money markets, but liquidity conditions remain fragile, as shown by high Libor rates," said Laurent Fransolet, head of European fixed-income strategy at Barclays Capital.

The official morning fixes from the British Bankers Association showed a very modest easing in overnight lending rates. Overnight Eurolibor fell to 4.1325 per cent on Monday from 4.205 per cent on Friday.

The Bank of Japan injected another Y600 billion into the money market on Monday in a one-week operation, following its Y1,000 billion emergency fund injection on Friday, to help ease pressure on interbank lending rates.

Overnight yen rates retreated to 0.68625 per cent from 0.75 per cent on Friday.

The Federal Reserve also continued to provide emergency liquidity on Monday with $2 billion of temporary reserves added in an overnight repo agreement. Last week the Fed pumped $38 billion into the banking system in three separate open market operations last week.

Overnight dollar rates eased to 5.77125 per cent from 5.95625 per cent.

The Bank of England remains the only major central bank to not have provided extra liquidity to the market. This was reflected in overnight sterling rates which rose to 6.50 per cent from 6.475 per cent on Friday.

The overnight LIBOR rates 'have not been as volatile, or as far above the UK base rate, since the Enron scandal in December 2001," said the British Bankers Association. "If the rates are significantly above the interest rates as set by the central bank, or government, it indicates that lenders are more worried about defaults on loans. Right now rates are high due to the knock-on effects of US sub-prime mortgage worries."

The Bank of Canada also intervened on Monday, injecting C$670 million to improve liquidity. This is the third occasion on which the Bank of Canada has intervened following a C$1.64 billion injection of overnight money on Thursday and the addition of C$1.685 billion via its Special Purchase and Resale Agreement on Friday.

"So far we have not seen a generalised blow-out of credit spreads," said Peter Hooper at Deutsche Bank: "What we are experiencing still seems more likely to turn out to be a return to more normal credit conditions after a period of 'irrational exuberance' than a major economy-damaging credit crunch."

However, Neil McLeish of Morgan Stanley voiced a more pessimistic view.

"We are well into the first stage of a credit bear market driven by rising corporate leverage and borrowing requirements, tighter global liquidity conditions, and, more subtly, gradually diminishing confidence on the part of both lenders and borrowers," said Mr McLeish.

Mr McLeish also said that it was important to understand that credit spreads would not widen in a straight line at this stage of the cycle.

Evidence from the last two cycles showed that spreads typically widen in a saw-tooth pattern, with sharp sell-offs interspersed with sometimes prolonged bear market rallies.

The ECB's one-day tender on Monday was its third special operation since last Thursday. It was awarded at a weighted average rate of 4.07 per cent. The ECB said 100 per cent of bids were accepted at the marginal rate of 4.06 per cent.

A total of 59 banks bid for E84.45 billion euros, compared with 62 banks bidding on Friday and 49 banks bidding on Thursday.

The highest bid rate was 4.10 per cent and the minimum bid was in line with the ECB's benchmark refinancing level of 4 per cent.

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