The ECB’s offer to lend to all takers who could post collateral for two weeks at 4.21% or higher led to an unprecedented $500 billion worth of advances. The New York Times and the Financial Times offer some insights as to what this portends. First, from the New York Times, which focused on the comments of Mervyn King, governor of the Bank of England:
Mervyn King, conceded on Tuesday that central banks, despite their ability to manufacture unlimited amounts of cash, are reaching the limits of their ability to ease the five-month-old credit crisis.
Despite a range of unusual liquidity injections, central banks in the United States, Europe and Britain have been unable to bring down spreads — the difference between their benchmark policy rates and rates that banks charge one another for short-term loans. The three-month lending rate fell a tenth of a percentage point, to about 4.8 percent, on Tuesday, far higher than normal….
“Even the operations we have put into place can’t be guaranteed and are unlikely to bring about a significant reduction in spreads except insofar as the operations can improve the confidence of the banking sector,” Mr. King told British lawmakers. “It’s hard to say whether it will turn out to be an important step.”….
Late Monday, the European Central Bank announced that it would guarantee unlimited two-week loans at a fixed rate of 4.21 percent, instead of taking its standard approach of fixing the amount it lends and allowing overall demand to determine the cost of borrowing. The normal tactic would have resulted in an infusion of about 180 billion euros, the bank said…
The scale of the effort left many market analysts puzzled as to why the bank stepped in so forcefully. Some speculated that the bank wanted to guard against a fresh outbreak of credit market chaos at the end of the year.
These observations come from the Financial Times:
Short-term market interest rates in the eurozone plunged at their fastest rate for more than a decade on Tuesday after the European Central Bank stunned investors by pumping a record €348.6bn worth of funds into the markets.
The size of the injection – which was intended to calm the markets over the critical year-end period – was twice as big as the ECB had indicated would have been needed in normal circumstances….
The bank said some 390 private sector banks in the eurozone had requested funds, which have been offered for two weeks at 4.21 per cent, well below the previous prevailing market rate.
“The sheer magnitude of the operation caught the market off guard,” said Win Thin, Brown Brothers Harriman’s senior currency strategist, who said there was talk that banks from the US and UK might have taken funds at lower rates than they could secure from their own markets.
The emergency operation, which followed last week’s co-ordinated effort by western central banks to ease pressures in the financial system, prompted the two-week euro London interbank offered rate (Libor) to fall a record 54 basis points to 4.40 per cent. The one-month and three-month rates recorded their biggest falls for nearly six years.
However, analysts warned further big declines were unlikely, given that tensions remained high in the financial world. There are also concerns in the market that the ECB may come under pressure to mop up any excessive liquidity to prevent the return of inflationary pressures….
However, a number of analysts fear banks are hoarding funds because they fear further big credit losses next year.
In another sign of mounting pressures, the ECB revealed that its emergency “marginal lending facility” – which attracts a penal interest rate – had been tapped for €2.44bn on Monday. That suggests some European banks still face considerable difficulties as a result of the global credit squeeze.