The world's top central banks joined forces on Thursday to throw a multi-bln dollar lifeline to global markets in a dramatic effort to free up bank-to-bank lending, frozen by the upheavals on Wall Street.
In an unprecedented move, the U.S. Federal Reserve made an extra $180 bln available to major central banks to lend on to their local commercial banks in a bid to get dollars circulating in overnight and term money markets.
Central banks including the Fed, the Bank of England and the European Central Bank also lent out extra funds in their own currencies as markets reeled in the wake of a round of takeovers and mergers among top financial firms and renewed concerns about how the U.S. economy will weather the storm.
Well-oiled money markets, where banks lend short term funds to each other to smooth out daily swings in their balances, are crucial for the proper functioning of the financial system and the economy at large.
Central banks have responded to a jump in interbank lending rates, exacerbated by investors' flight into safe havens of gold and government bonds, by flooding markets with cash and verbal reassurances but so far with only limited success.
Analysts said the extra funds calmed markets, but this would likely prove only temporary and noted mixed demand from banks for the extra funds on offer in the auctions on Thursday.
While euro-zone banks bid heavily for both dollars and euros, their British counterparts showed little interest at the BoE's first dollar auction but bid 202.03 bln pounds ($359.9 bln) for the 66.21 bln pounds on offer in an open market operation — the equivalent of 1/7 of the UK economy.
The Bank of Japan and the Bank of Canada also took part in the global action, in place until the end of January next year, and agreed new dollar swap lines with the Fed, although they did not announce immediate plans to use them.
"These measures, together with other actions taken in the last few days by individual central banks, are designed to improve the liquidity conditions in global financial markets," the central banks said in simultaneous statements released just after 0700 GMT.
"The central banks continue to work together closely and will take appropriate steps to address the ongoing pressures."
The move surpasses emergency measures taken since August last year — which included the ECB and Swiss National Bank lending longer-term but not overnight dollars — and currency swap lines agreed following the Sept. 11, 2001 attacks.
It follows a rout in markets gripped by fears of more Wall Street failures after Lehman Brothers filed for bankruptcy, Merrill Lynch lost its independence, an $85 bln U.S. government bailout of insurer AIG and Morgan Stanley searching for a buyer.
The Swiss National Bank, which is also part of the agreement, kept interest rates on hold on Thursday citing major uncertainties about the global economy and the impact of market moves and calling these "a matter for concern".
A Group of Seven source said there were no plans for an extra meeting of policymakers from industrialised nations to discuss the market moves ahead of a planned G7 meeting in Washington in October, but there were regular talks.
The deputy economy minister of G7 member Germany said the country was a stabilising force amid market chaos, adding that Germany and Switzerland "didn't make Anglo-Saxon mistakes. We didn't bet everything on financial services."
Still, news of the coordinated action brought some relief to markets, buoying bank stocks and bond yields and cutting dollar borrowing costs. Overnight U.S. dollar interbank interest rates dropped as low as 2%, matching the Fed's target rate, according to Reuters data.
Overnight dollar Libor rates fixed at 3.84375% from 5.03125% on Wednesday, although three-month rates rose across the board and the premium over expected official rates continued to rise.
"What we're looking at is a complete breakdown of the interbank lending market," said Sean Maloney, rates strategist at Nomura International. "What central banks have done has definitely eased the situation, but it's not enough on its own to cure the problem, hence spreads are still widening."
RESULTS MIXED
Demand at the dollar auctions conducted in the UK, the euro zone and Switzerland on the first day of the global deal was patchy.
British banks took up only $14 bln, a third of the funds on offer from the BoE, at a weighted average rate of 3.802%. The SNB lent out its full $10 bln after banks bid for $10.17 bln, less than the demand typically seen at 28- and 84-day dollar auctions.
In contrast, euro-zone banks bid for more than $100 bln in dollar funds, more than double the $40 bln on offer, and paid a marginal rate of 4%.
Demand was also strong at a separate one-day auction of overnight euros, with banks asking for 50 bln in the open-ended operation, although they received 25 bln ($35.5 bln).
Barry Moran, senior money market trader at the Bank of Ireland, said the difference in demand at the dollar auctions was partly explained by the ECB accepting a broader range of assets as collateral than the BoE.
"The markets are still very, very jittery," he said.
"I think the coordinated attempts — particularly on the dollar sides — has helped a little bit."
"But it's only short term, though the amounts are very large."
In other signs of banks' thirst for funds, the New York Fed logged bids of more than $100 bln in a $50 bln overnight operation and central banks in Japan, Australia and India pumped a further $28 bln into their money markets.
China relaxed its policy for the second time this week, South Korea sold dollars in the swap market and said it would try to halt the slide in bond prices, the Philippines intervened to support the peso, and Taiwan warned it could use a state fund to prop up stocks as markets whipsawed across the region facing its toughest test since the Asian financial crisis of 1997.
Russia will assign 500 bln roubles ($19.59 bln) to support and stabilise the stock markets, where trade will resume on Friday, the country's leaders said. President Dmitry Medvedev said that half of the 500 bln roubles will come from the budget, and that further measures could be taken if necessary.
