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Central banks fail to calm money markets as cash hunger grows

Section: Daily Dispatches

Central Banks' Actions
Fail to Calm Money Markets

By Michael Mackenzie, Stacy-Marie Ishmael,
Ralph Atkins, and Gillian Tett
Financial Times, London
Tuesday, September 25, 2007

The European Central Bank faced a fresh surge in demand for liquidity on Tuesday when it allocated weekly refinancing funds at an average of 4.29 percent, the highest spread over the minimum bid rate for almost five years.

The unexpectedly strong appetite suggests the ECB is again facing difficulties bringing interest rates in line with its 4 percent main rate. Tuesday's auction bids totalled E369 billion compared with its estimated "benchmark" requirement of E157 billion.

The pattern is likely to trigger unease among policy makers since it suggests the mood in the global money markets remains nervous, irrespective of the emergency actions taken by central banks in recent days.

The Bank of England will on Wednesday conduct an auction of L10 billion worth of three-month money, the first of four weekly sales designed to help lenders, and this is expected to provide another key indication of how badly the banks need cash.

In recent days, the cost of borrowing sterling on an overnight basis and three-month basis has fallen back slightly. However, by historic standards, it remains elevated and some bankers say the true cost of borrowing funds is higher than official quotes suggest.

Meanwhile in the US, the euphoria that galvanised investors after the Federal Reserve cut rates last week is fading as the focus shifts to how a slower US economy and the housing slump will affect the credit and mortgage markets.

"The future of housing is still very much in doubt and will likely continue to be that way for quite some time," said Kevin Giddis, managing director, fixed income at Morgan Keegan & Co. "The market's view today is that this will depress the other parts of the US economy and the Fed will be forced to act again."

In the wake of the Fed's rate cut, equities posted their strongest weekly performance since March. However, the tone of credit and mortgage markets has soured this week as the dollar has set a string of record lows against the euro. Further deterioration in the housing sector is also creating losses. The riskiest slice of the ABX index, which tracks subprime mortgage bonds, fell to a new low of 29.5 cents on the dollar on Tuesday.

"Most of the eventual loan delinquencies and foreclosures in recently originated subprime mortgage securitisations have yet to translate into realised capital losses," said Derrick Wulf, portfolio manager at Dwight Asset Management.

Though US money markets initially improved after the rate cut, some interbank rates remain elevated compared with the 4.75 per cent Fed funds rate. And the failure of the London interbank offer rate (Libor) to fall further since the Fed meeting has sparked a breakdown in the December eurodollar interest rate future. One-week US dollar Libor has moved higher in recent days and traders say there are funding concerns as the third quarter ends on Friday.

"It appears we will need to get through this week's quarter-end book squaring before we'll see further improvement in money markets," said Ted Wieseman, economist at Morgan Stanley.

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