A wave of central bank action around the world to avert a liquidity crisis cheered financial markets on Wednesday but highlighted the depth of international concern about possible economic turmoil in Europe.
In a co-ordinated move with other central banks the US Federal Reserve slashed the penalty rate that it charges them on dollar liquidity from 100 to 50 basis points. Earlier, China made a decisive shift towards easier monetary policy and Brazil last night cut its benchmark Selic interest rate by 50 basis points for the third time since August, citing adverse global economic conditions.
US and European equities rose sharply after the move on Wednesday, with the FTSE 100 closing up 3.1 per cent and the S&P 500 up 4.3 per cent in New York. But analysts warned that the move had not addressed the fundamental issues behind the eurozone’s sovereign debt crisis. The Dow Jones Industrial Average rose nearly 500 points, its best one-day gain since March 2009. The euro jumped 1 percentage point against the dollar.
But analysts warned that the move did not address the fundamental issues behind the eurozone’s sovereign debt crisis.
“The provision of liquidity is no substitute for other actions that Europe must take to solve its current woes,” said Tony Crescenzi, strategist at Pimco. “The world continues to wait on European actions on fiscal rules, discipline, and enforcement, as well as use of the balance sheet that matters most in the current situation: the European Central Bank.”
China said it would reduce the portion of deposits that banks must hold in reserve from 21.5 per cent to 20 per cent, the first such cut in three years, and an indication that emerging markets are now more worried about the threat to growth than the risks of inflation.
The cheaper dollar swap lines with the Fed will let the ECB provide cheaper dollar loans to European commercial banks. The change is a tacit admission that the existing swap lines were not attractive to European banks. Only $2.4bn was drawn on them last week.
As the eurozone debt crisis has escalated, the region’s banks have faced increased difficulties in obtaining financing, including in dollars. In a similarly co-ordinated central bank action in September, Europe’s central banks announced plans to offer banks three-month dollar liquidity. But Wednesday’s move was a tacit admission that currency swap lines in place with the Fed as part of that deal were not effective at the higher price. In an ECB offer of three-month dollar liquidity earlier this month, just four eurozone banks borrowed a total of only $395m.
“The main reason for banks not using the swap lines is probably stigma. It’s the danger that somebody will find out and say: ‘Why are you going to the central bank, rather than the money markets, where you can borrow much more cheaply?’,” said Walter Meier, a spokesperson for the Swiss National Bank, which has not seen any demand for dollar funds since mid-August.
The move may also be the first stage of an escalated response by the ECB. It is widely expected to announce next week that it will offer euro loans to banks lasting as long as three years, compared with the current 13-month maximum.
In a further move to boost the attractiveness of its dollar loans, the ECB said it would demand less collateral in return, cutting the margin, or discount, on assets pledged from 20 per cent to 12 per cent.
A Franco-German push for greater fiscal union in Europe could pave the way for more aggressive government bond buying by the ECB. . One possibility being looked at by the ECB is a limit on government bond yields, or on the spread between the interest rate on German and other government bonds – although such moves would probably be resisted by the Bundesbank.
Troubled eurozone bond markets saw big gains as yields, which have an inverse relationship with prices, fell in almost every country in the single currency bloc. In Italy, which has been one of the most stressed markets, yields dropped nearly a quarter of a point on 10-year debt, although they remained above 7 per cent – a level considered unsustainable by markets.
Earlier in the day, before the central bank action, German Bund yields for one-year debt went negative in a sign of the strains in the market as money flowed to Berlin’s markets. Fretting investors were prepared to pay for the privilege of lending to Germany over one year.
Reporting by Robin Harding in Washington, Ralph Atkins in Frankfurt, Claire Jones and David Oakley in London, Joseph Leahy in São Paulo and Michael Mackenzie in New York
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