After some stabilisation over the previous few days, markets were hit by another bout of turmoil yesterday. The proximate trigger this time appears to be Europe, although the ultimate source remains the US mortgage market.
From Bloomberg:
The European Central Bank, in an unprecedented response to a sudden demand for cash from banks roiled by the subprime mortgage collapse in the U.S., loaned 94.8 billion euros ($130 billion) to assuage a credit crunch.
The overnight rates banks charge each other to lend in dollars soared to the highest in six years within hours of the biggest French bank halting withdrawals from funds linked to U.S. subprime mortgages. The London interbank offered rate rose to 5.86 percent today from 5.35 percent and in euros jumped to 4.31 percent from 4.11 percent.
The ECB said it would provide unlimited cash as the fastest increase in overnight Libor since June 2004 signaled banks are reducing the supply of money just as investors retreat because of losses from the U.S. real-estate slump. Paris-based BNP Paribas SA halted withdrawals from three investment funds today because the French bank couldn't value its holdings. Stocks in the U.S. and Europe fell, a turnaround from the past three days when investors concluded that credit market risks were abating.
Later yesterday, the Federal Reserve had to respond similarly.
The U.S. Federal Reserve added $24 billion in temporary reserves to the banking system today, the most since April. Fed spokesman David Skidmore declined to comment on the increases in overnight money-market rates.
"This is an old-fashioned credit crunch," Chris Low, the chief economist at FTN Financial in New York, said in a report today. "This is not a small thing. A credit crunch, when the short-term credit markets seize up, is extraordinarily serious, almost always the precursor of a significant recession."
Today, it is the Bank of Japan's turn.
The Bank of Japan added 1 trillion yen ($8.49 billion) to the financial system, joining central banks in the U.S. and Europe in supplying cash to assuage a credit crunch.
While a lot of attention has been paid to the ECB's injection of funds, the central bank's release of its monthly bulletin was relatively neglected. But Bloomberg has the story.
The European Central Bank said interest rates are still boosting economic growth and financing conditions are "favorable," suggesting it sees scope to raise borrowing costs further.
"The ECB's monetary policy is still on the accommodative side," the Frankfurt-based central bank said in its monthly bulletin published today. "Strong vigilance is of the essence in order to ensure that risks to price stability over the medium term do not materialize."
If that report downplays the risks to the financial system, it is perhaps understandable. Indeed, before the storm broke in Europe, South Korea's central bank had raised interest rates yesterday.
The Bank of Korea unexpectedly raised its benchmark interest rate for a second time in two months to curb lending that may fuel asset-price bubbles.
Governor Lee Seong Tae and his board increased the overnight call rate by a quarter point to 5 percent, the highest since July 2001, the central bank said in Seoul today. None of the 14 economists surveyed by Bloomberg News predicted the move.
And more monetary tightening among central banks would certainly look like the correct action to take considering that even a relatively mature economy like Singapore's is growing at a double-digit rate. From Channel NewsAsia today:
The economy has picked up pace in the second quarter, with GDP expanding by 8.6 per cent year-on-year following 6.4 per cent in the previous quarter, according to data released by the Ministry of Trade and Industry on Friday.
Growth on a seasonally-adjusted quarter-on-quarter annualised basis increased to 14 per cent from 8.8 per cent in the first quarter.
This is going to be a very tricky period for central banks.
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