Last updated: May 7, 2010 12:03 pm

Bank of Japan pumps funds into market

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The Bank of Japan offered Y2,000bn ($21.6bn) in overnight liquidity on Friday to “increase markets’ sense of security” because of turmoil resulting from the debt crisis in Greece.

It is the bank’s first exceptional offer of overnight funds since the scare over Dubai’s sovereign debt in December 2009 and its biggest since the height of the financial crisis in December 2008.

The move shows that fears about sovereign debt default in Europe are rippling across global markets, with the Bank of Japan the first central bank to react by adding liquidity. This, however, does not reflect any significant market disruption in Japan or any fears of contagion to Japan, despite its own debt woes.

Instead, the bank’s action reflects global demand for dollar liquidity as investors move out of the euro. That has pushed up short-term US dollar interest rates and created a knock-on demand for yen liquidity as a substitute.

“It’s because of signs of difficulties in the global money markets. There is lots of demand for US dollars,” said one fixed income strategist.

The strategist said the the bank’s move looked reactive but it was an unusually quick response to market conditions.

The Reserve Bank of Australia on Friday separately warned the world was at risk of a fresh bout of risk aversion if Europe’s fiscal problems intensified. “If this were to occur abruptly, it could prompt another period of global economic weakness and falls in commodity prices,” the bank said.

Yen-dollar basis swaps, which measure the cost of borrowing in yen for three months at a floating rate minus the same cost in dollars, have moved from minus 25 basis points to minus 35.3 basis points in the past two days. That means it has become relatively more expensive to borrow in dollars.

The BoJ’s move soon started to take effect in the markets. The yen fell from about Y91.70 when the central bank added the funds to Y92.37 as of early evening on Friday in Tokyo. The stock market also erased some of their earlier losses. The Nikkei 225 closed down 3.1 per cent at 10,364.59 on Friday, compared with a drop of 4.1 per cent at the open. The two-year yen-dollar basis swap improved to minus 34.875 basis points.

Demand for the funds offered by the BoJ was moderate with bids for only Y1,664bn of the funds on offer. Y1,564bn worth of bids were accepted.

The Australian central bank on Tuesday lifted its benchmark interest rate for a sixth time since October.

“If this were Tuesday morning three days ago, the RBA board would have held its fire and not hiked rates,” said Rory Robertson, interest rate strategist at Macquarie Group, the Australian investment bank. “This lack of ‘contagion’ ended within hours of the RBA pushing the rates button.

“The unpleasant risk that problems in Europe ultimately will drag down the global economy and markets seems somewhat greater today than a week ago.”

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