International effort to soothe banks’ fears is well received

Mar 12 2008 by Iain Laing, The Journal

THE latest effort to ease the credit squeeze in money markets has been unveiled by central banks across the world.

Billions extra will be pumped into the financial system by five central banks – including the Bank of England – to ease the growing pressure in money markets.

The news boosted stock markets, with London’s FTSE 100 Index up more than 2% after the announcement.

The UK’s major banks rose strongly on the news, with Royal Bank of Scotland up 8% and Barclays up 7%.

The US Federal Reserve said it was ready to pump in £99.5bn to improve liquidity in financial markets, over and above the measures it announced on Friday.

And the Bank of England is making £10bn extra available at three-month terms “in view of continuing elevated pressures in short-term funding markets”.

It will offer the extra cash to ease the pressure on banks reluctant to lend to each other since the freeze in financial markets last year.

The rate at which banks lend to each other for three months has crept steadily higher since the last co-ordinated intervention last January, prompting yesterday’s move. The European Central Bank, the Bank of Canada and the Swiss National Bank are also involved in the drive, which began last December.

The five banks said in a joint statement: “Central banks have continued to work together closely and to consult regularly on liquidity pressures in funding markets.

“Pressures in some of these markets have recently increased again. We all continue to work together and will take appropriate steps to address those liquidity pressures.”

The Bank of England is also accepting the wider range of collateral for the money from borrowers – including mortgage-backed bonds – which it set out three months ago. It could decide to offer increased funds next month as well.

Central banks have been forced to take action since a crisis of confidence over mortgage-backed assets erupted last summer after rising defaults among high-risk US homeowners.

Cautious banks have hoarded cash and borrowing costs have risen, causing the funding crisis and eventual nationalisation of mortgage lender Northern Rock.

The rate at which banks lend to each other for three months stood at 5.79% before yesterday’s developments – its highest level since January 3. The Bank of England’s current base rate is 5.25%. Policymakers will be looking for the rate to fall today as a signal of easing pressure in money markets.