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Frustrated ECB promises banks infinite money at a discount

Section: Daily Dispatches

ECB Steps Up Fight to Safeguard Liquidity

By Ralph Atkins, Gillian, Krishna Guha
Financial Times, London
Monday, December 17, 2007

Emergency help for financial markets entered new territory on Monday night as the European Central Bank announced that it would on Tuesday offer unlimited funds at below-market interest rates in a special operation to head off a year-end liquidity crisis.

The surprise move, which follows last week's co-ordinated barrage of measures by the world's central banks to increase market liquidity, suggests the ECB is still frustrated at the failure to ease market tensions.

The measure was reminiscent of the ECB's operation on August 9, at the start of the global credit squeeze. But that was for overnight loans while the new offer is for two weeks.

Analysts warned that the measure risked increasing market volatility and saw the central bank breaking new ground in helping out the banking sector.

"This is basically Father Christmas to those who have access," said Erik Nielsen, economist at Goldman Sachs. "They are bailing out people who have not really adjusted their balance sheets to the new reality."

But Julian Callow, economist at Barclays Capital in London, said the funds injected would later be "mopped up" by the ECB, which was "simply doing their job at being lender of last resort."

The ECB had already announced that Tuesday's regular weekly money market operation would mature on January 4 -- covering the year-end when financial institutions will be under pressure to show strong liquidity on their books.

But on Monday night it said in addition that it would satisfy all bids offering 4.21 per cent or more. Prior to the announcement, the cost of borrowing two-week money had soared to 4.9 per cent but fell sharply afterwards as the ECB's move in effect put a cap on market interest rates.

The move could trigger a surge in demand for ECB liquidity. In last week's regular seven-day auction, the ECB allocated E218.5 billion at an average rate of 4.21 per cent -- the rate chosen as the cap for today's operation.

The ECB offered little explanation for its move beyond saying it was "fully consistent" with its aim of keeping rates close to its main policy rate of 4 per cent.

The latest move underlines the limited impact of last week's co-ordinated intervention, which included a new liquidity facility at the US Federal Reserve.

The Fed held the first of its new credit auctions on Monday, offering $20 billion in one-month loans in an effort to ease strains in the term money market.

The Bank for International Settlements on Monday published a report on the different money market operations that are used by central banks -- the first such study that has ever been conducted by the Basel-based group.

It refrained from drawing precise policy conclusions but it noted that there is a striking variation in the techniques used.

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