World’s Central Banks Act to Ease Market Strains

By Beacon Staff

FRANKFURT, Germany – Major central banks around the globe took coordinated action Wednesday to ease the strains on the world’s financial system, saying they would make it easier for banks to get dollars if they need them. Stock markets and the euro rose sharply on the move.

The U.S. Federal Reserve, European Central Bank, Bank of England and the central banks of Canada, Japan and Switzerland were all taking part.

“The purpose of these actions is to ease strains in financial markets and thereby mitigate the effects of such strains on the supply of credit to households and businesses and so help foster economic activity,” the central banks said in a joint statement.

The announcement came just hours after China reduced bank reserve levels Wednesday to release money for lending and help shore up slowing growth. It was the first easing of Chinese monetary policy in three years — and higher growth in China could be crucial for a suffering global economy.

Stocks surged following the news. The Dow Jones industrial average jumped more than 400 points in early trading and was up 392 an hour after the opening bell. Germany’s DAX was trading 4.7 percent higher, France’s CAC was up 4.1 percent, the euro rose 1.1 percent to $1.3463 and oil was up $1.45 to $101.25.

As Europe’s debt crisis has spread, the global financial system is showing signs of entering another credit crunch like the one that followed the 2008 collapse of U.S. investment bank Lehman Brothers. Banks are afraid to lend to each other, since no one is really sure what institutions are holding how much bad government debt.

Greece, Ireland and Portugal have all been forced to take international bailouts, and Italy, Spain and Belgium are seeing their borrowing costs rise sharply. Banks already had to agree to forgive 50 percent of the value of their Greek debt holdings — and many fear that other struggling European countries might also demand a so-called “haircut” on bonds.

A ratings downgrade by Standard & Poors for six major U.S. banks on Tuesday added to fears that Europe’s woes would hurt the entire financial system. If one or more European governments default, that would unleash a shock to the world’s financial system that at the very least would lead to recessions in the United States and Europe, severe losses for banks and a global stranglehold on lending.

The central banks agreed to reduce the cost of temporary dollar loans they offer to banks — called liquidity swaps — by a half percentage point. The new, lower rate will be applied to all central bank operations starting Monday.

The cut means that the charge will fall to 50 basis points — or one-half percentage point — over an international benchmark, the overnight index swap rate, which is averaging around seven to 10 basis points currently.

Non-U.S. banks need dollars to fund their U.S. operations and to make dollar loans to companies that need the U.S. currency. The dollar is the world’s leading currency for central bank reserves and is widely used in international trade.

“Obviously, these moves are designed to increase the flow of dollar liquidity to European banks, which are struggling to attract short-term funding because of questions about their exposure to potential losses on holdings of European sovereign bonds,” said Paul Ashworth, chief U.S. economist at Capital Economics.

He explained that Wednesday’s move does not expose the Fed to propping up ailing European banks.

“The ECB actually makes the loans to these banks, so the Fed is not on the hook for any losses if a European bank failed,” Ashworth added.

The announcement also extended the length of time the temporary dollar lines will be available by six months to Feb. 1, 2013. The swap line program had been scheduled to end Aug. 1, 2013.

According to Federal Reserve figures, $2.4 billion in swap lines were being used as of last week. By comparison, at the height of the 2008 financial crisis, $580 billion was provided in temporary swap lines in December of that year.

The central banks are also taking steps to ensure that banks can get ready money in any of their currencies if market conditions warrant by establishing a temporary network of reciprocal swap lines.

Right now there is no need to offer non-domestic credits in currencies other than the dollar, the central banks said, but they “judge it prudent” to get such an arrangement in place ahead of time.

Fears of more financial turmoil in Europe have already left some European banks dependent on central bank loans to fund their daily operations. Other banks are wary of lending to them for fear of not getting paid back. Such constraints on interbank lending can hurt the wider economy by making less money available to lend to businesses.