Central banks turn on funding taps to tackle market squeeze

The world's top central banks joined forces on Thursday to throw a multi-billion dollar lifeline to global markets in a dramatic effort to free up bank-to-bank lending, frozen by the upheavals on Wall Street.
In a surprise move, the U.S. Federal Reserve made an extra $180 billion available to central banks around the world 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 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 auctions on Thursday.
While euro-zone banks bid heavily for both dollars and euros, their British counterparts showed little interest in dollars but bid 202.03 billion pounds ($359.9 billion) for the 66.21 billion pounds on offer in a BoE 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, which runs 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 concerted action follows a rout in financial markets, gripped by fears of more Wall Street failures after a week that saw Lehman Brothers file for bankruptcy, Merrill Lynch lose its independence, an $85 billion U.S. government bailout of insurer AIG and Morgan Stanley search for a buyer.
The news pushed U.S. and euro zone bond futures down, boosted bank stocks and cut dollar borrowing costs. Overnight U.S. dollar interbank interest rates dropped as low as 2 percent, matching the Fed's target rate, according to Reuters data . Overnight dollar Libor rates fixed at 3.84375 percent from 5.03125 percent on Wednesday, although three-month rates rose across the board .
"Obviously it does not tackle the underlying root causes of the problem, but it does help to release some of those immediate tensions that have been building up in the money market," Ian Stannard, senior currency strategist at BNP Paribas in London.
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 billion, a third of the funds on offer from the BoE, at a weighted average rate of 3.802 percent. The SNB lent out its full $10 billion after banks bid for $10.17 billion, less than the demand typically seen at 28- and 84-day dollar auctions.
In contrast, euro-zone banks bid for more than $100 billion in dollar funds, more than double the $40 billion on offer, and paid a marginal rate of 4 percent.
Demand was also strong at a separate one-day auction of overnight euros, with banks asking for 50 billion in the open-ended operation, although they received 25 billion ($35.5 billion).
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.
"I think the coordinated attempts — particularly on the dollar sides — has helped a little bit," he said.
"But it's only short term, though the amounts are very large."
"The markets are still very, very jittery."
Earlier in the day, central banks in Japan, Australia and India pumped a further $28 billion into money markets while 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 it toughest test since the Asian financial crisis of 1997.
Russia will assign 500 billion roubles ($19.59 billion) to support and stabilize the stock markets, where trade will resume on Friday, the country's leaders said. President Dmitry Medvedev said that half of the 500 billion roubles will come from the budget, and that further measures could be taken if necessary.