Sharp fall in overnight borrowing rates

The volatility in wholesale money markets was underscored on Wednesday with big reductions in overnight unsecured interest rates, but rises in the cost of three-month money.

The Libor rate for overnight US dollar borrowing was fixed at 3.79 per cent, a plunge from 6.87 per cent on Tuesday, with a similarly large fall seen in sterling overnight interest rates.

But for those banks able to borrow longer-term, whether in dollars, euros or sterling, the interest rates on three-month money rose – up to 4.15 per cent in the US, 5.28 per cent in the eurozone and 6.31 per cent in the UK.

The collapse of trust in money markets has led to more than €100bn being parked overnight at the European Central Bank – by far the highest amount ever, underscoring the extent of stress in the global financial system.

Banks are increasingly dealing with central banks rather than each other as the crisis of confidence persists, but central banks around the world are finding it difficult to judge demand for funds as every bank’s needs are different.

The €102.8bn left on Tuesday night in the ECB’s deposit facility, which pays a below-market interest rate of 3.25 per cent, highlighted banks’ reluctance to deal with each other. The sum was more than double the amount deposited on Monday night.

At the same time, other banks borrowed almost €16bn from the central bank’s marginal lending facility, which incurs a penalty interest rate of 5.25 per cent.

For a smaller economy, a similarly large amount of money – some £7bn – was squirreled away by UK banks in the Bank of England’s equivalent deposit facility on Tuesday night, earning an interest rate of 4 per cent, a percentage point below the Bank’s policy rate.

The Bank of England is now planning to drain £10bn of cash from banks that have found themselves awash with overnight money but are reluctant to lend it out.

In a sign of the difficulties of working out how much money to pump into the banking systems, the UK central bank offered two US dollar auctions on Wednesday morning, one overnight and one for a week, but found demand thin for both. Less than half the money offered was taken up in the $30bn weekly auction.

Since the failure of the US authorities’ $700bn bail-out plan, the ECB has dramatically expanded its financial market liquidity boosting operations.

In the latest move on Wednesday it pumped in an extra $50bn of overnight dollar liquidity at an interest rate of 3.25 per cent.

Jean-Claude Trichet, ECB president, pledged in a speech in Frankfurt late on Tuesday that the central bank would continue to support solvent banks’ access to liquidity and the functioning of money markets for “as long as necessary”.

But, separately, he also highlighted European policymakers’ concern about the scale of the global financial crisis when he urged US politicians to revive the planned rescue plan.

“It has to go, for the sake of the US and for the sake of global finance,” Mr Trichet said in an interview with Bloomberg Television.

The ECB has so far stuck to a strict separation of measures to help financial market liquidity and its monetary policy aimed at combating inflation. Its governing council is widely expected to keep the main policy rate unchanged at 4.25 per cent when it gathers in Frankfurt on Thursday.

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