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ECB offers banks unlimited cash

Section: Daily Dispatches

Trichet Can't Rule Out More Cuts, Offers Cash Flood

By Simone Meier and Christian Vits
Bloomberg News
Wednesday, October 8, 2008

FRANKFURT, Germany -- European Central Bank President Jean-Claude Trichet said he can't rule out further interest-rate cuts after joining a round of global reductions today and offering to flood the banking system with as much cash as it needs.

The Frankfurt-based ECB lowered its key lending rate by half a point to 3.75 percent and said it will start lending banks unlimited cash in its weekly auctions at the new benchmark. Asked if the rate cut was a one-off, Trichet replied: "I don't say that. I say that we will always do whatever is necessary."

The world's largest central banks today cut borrowing costs in a coordinated effort after the credit crunch spread from the U.S., pushing up lending costs and forcing governments in Europe and the U.S. to bail out banks. After an initial rally, European stocks fell, sending the Dow Jones Stoxx 600 Index to its worst three-day retreat since October 1987, on concern the coordinated action won't prevent a global recession.

"The ECB has come a long way in a very short time, having hiked in July," said Matthew Sharratt, an economist at Bank of America Corp. in London. "The hope is that this will shore up sentiment. The markets are nervous. The jury is still out."

Commercial banks are refusing to lend to each other after the U.S. housing slump caused the collapse of New York-based Lehman Brothers Holdings Inc. That's pushed market interest rates to records even as the ECB and other central banks injected billions of euros and dollars into the banking system.

... 'Strongest Weapon'

By deciding to lend banks as much cash as they want at the benchmark rate, rather than at a rate determined by demand, the ECB "is now really deploying its strongest weapon to bring money-market rates down," said Stefan Bielmeier, an economist at Deutsche Bank AG in Frankfurt. "This brings them closer to becoming a European clearing house."

The ECB also narrowed the corridor around its key rate to 100 basis points from 200 points. That means it reduced the cost of emergency overnight cash to 4.25 percent from 4.75 percent and raised the rate it pays banks for overnight deposits to 3.25 percent from 2.75 percent.

"The decision just made by the ECB to open liquidity, to tell banks 'if you need financing, come refinance yourself here, you can do it at fixed rates without limit,' is the sort of decision that may unfreeze the system," French Finance Minister Christine Lagarde said on France 2 television.

Today's moves by the ECB come as the 15-nation euro-region teeters on the brink of a recession and banks reel from the shortage of credit. Governments in Germany, France, Belgium, and Luxembourg have been forced to step in and rescue ailing banks.

... 'Signal of Confidence'

"It was appropriate to give a very powerful signal of confidence and of intimate cooperation," Trichet said of today's the coordinated response to the crisis.

The U.S. Federal Reserve cut its benchmark rate by a half point to 1.5 percent. The central banks of the U.K., Canada, Sweden, and Switzerland also reduced borrowing costs. China cut interest rates for the second time in three weeks.

Investors have fully priced in another ECB rate cut in December and expect the bank's benchmark to be at 3 percent by March, according to Eonia forward contracts.

"There will be more rate cuts because the economy is moving into a recession," said Joerg Kraemer, chief economist at Commerzbank AG in Frankfurt. "At the same time, declining raw-material costs are pushing down inflation."

The ECB raised rates in July and has held off reducing them because of its concern that faster inflation will trigger a wage- price spiral as workers seek compensation for the higher cost of living.

While inflation slowed to 3.6 percent in September from a 16-year high of 4 percent in July, it remains above the ECB's 2 percent limit. Germany's IG Metall labor union, representing 3.2 million workers, is seeking the biggest pay increase in 16 years.

"Today's move should not be seen as a first step in a possible series" of rate reductions, ECB council member Ewald Nowotny said in an interview. The new level of rates "will ensure that inflation expectations remain anchored" and "the situation has to be assessed as we go along," Nowotny said.

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