Bloomberg News

Central Banks Cut Swap Rate in Global Bid to Ease Crisis

November 30, 2011

(Updates with Fed comment in 10th paragraph.)

Nov. 30 (Bloomberg) -- Six central banks led by the Federal Reserve lowered the cost of emergency dollar funding for financial companies in a global effort to ease Europe’s sovereign-debt crisis.

The new interest rate is the dollar overnight index swap rate plus 50 basis points, a half percentage-point cut, and the program was extended by six months to Feb. 1, 2013, the Fed said today in a statement in Washington. The Fed coordinated the move with the European Central Bank as well as the Bank of Canada, Bank of England, Bank of Japan, and Swiss National Bank.

U.S. and European stocks rallied on the move aimed at easing strains in markets and boosting central banks’ capacity to support the global financial system. The cost for European banks to fund in dollars rose to the highest levels in three years today as concerns about a possible breakup of the euro area increased after leaders said they’d failed to boost the region’s bailout fund as much as planned.

“It’s a step in the right direction,” said Jay Bryson, global economist with Wells Fargo Securities in Charlotte, North Carolina. “It doesn’t solve the problem in Europe, but to the extent that European banks are having trouble raising dollar funding, it makes it easier and less costly for these banks to borrow dollars.”

The six central banks also agreed to create temporary bilateral swap programs so funding can be provided in any of the currencies “should market conditions so warrant.” Those swap lines were also authorized through Feb. 1, 2013.

Starting December

The dollar swap lines were previously set to expire Aug. 1, 2012. The new pricing will be applied to operations starting on Dec. 5. Seven-day loans would carry an interest rate of about 0.58 percent, down from 1.08 percent, based on the current one- week OIS rate of 0.08 percent.

“This was in response to increased tension in global financial markets,” Bank of Japan Governor Masaaki Shirakawa said at a press conference in Tokyo today. “Coordinated action will give markets a sense of security.”

Stocks and the euro rallied after the announcement, while Treasuries fell.

The Standard & Poor’s 500 index jumped 3.2 percent to 1,234.41 at 10:20 a.m. in New York and the Stoxx Europe 600 Index surged 3.3 percent. The euro rose to $1.3466 from $1.3317 late yesterday. The yield on the 10-year Treasury note climbed to 2.09 percent from 1.99 percent.

“When there’s concerted action by central banks, it’s definitely good,” said Jens Sondergaard, senior European economist at Nomura International Plc in London. “But are liquidity injections a game changer when the heart of the problem is in European sovereign debt markets?”

European Banks

European banks gained, with Barclays Plc climbing as much as 9.4 percent in London trading. Deutsche Bank rose as much as 7.3 percent in Frankfurt, while BNP Paribas SA and Credit Agricole SA gained in Paris.

Today’s move echoes coordinated actions from the financial panic starting in 2007 to create and expand the currency-swap lines, whose use peaked at about $583 billion in December 2008. The central banks also jointly lowered their benchmark interest rates in October 2008.

The Fed said U.S. financial companies “currently do not face difficulty obtaining liquidity in short-term funding markets.”

“However, were conditions to deteriorate, the Federal Reserve has a range of tools available to provide an effective liquidity backstop for such institutions and is prepared to use these tools as needed to support financial stability and to promote the extension of credit to U.S. households and businesses,” the central bank said in the statement.

China Move

Two hours before the Fed announcement, China cut the amount of cash that the nation’s banks must set aside as reserves for the first time since 2008. The level for the biggest lenders falls to 21 percent from a record 21.5 percent, based on past statements.

While today’s move by the six central banks is likely to ease tensions in money markets, it falls short of some calls for the ECB to step up and act as lender of last resort for the governments of the 17-member euro area and buy unlimited amounts of government bonds. Germany, Europe’s largest economy, has resisted the idea, arguing it isn’t the ECB’s job to do so and would only be a temporary fix.

The ECB unexpectedly cut its benchmark interest rate Nov. 3 by 25 basis points to 1.25 percent as the turmoil threatened to drag the euro area into recession. ECB policy makers next meet Dec. 8, while Fed officials gather Dec. 13.

Seven-Day Refinancing

Yesterday, the ECB allotted the most to banks in its regular seven-day refinancing operation in more than two years, lending 265.5 billion euros ($357.5 billion). The ECB offers unlimited funding to euro-area banks against eligible collateral.

“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 Fed statement said.

Under the dollar liquidity-swap program, the Fed lends dollars to the ECB and other central banks in exchange for currencies including euros. The central banks lend dollars to commercial banks in their jurisdictions through an auction process.

The swap arrangements were revived in May 2010 when the debt crisis in Europe worsened. The Fed three months earlier had closed all swap lines opened during the financial crisis triggered by the subprime-mortgage meltdown in 2007.

Dollar Tender

European lenders asked for a total of $395 million in the ECB’s 84-day dollar tender conducted in coordination with the Fed on Nov. 9. In the first offering on Oct. 12, the ECB lent six banks $1.35 billion for three months. The next three-month loan will be offered on Dec. 7.

The coordinated action “lowers the cost of emergency funding and increases the scope,” Mohamed El-Erian, chief executive officer, of Pacific Investment Management Co. said in a radio interview today on “Bloomberg Surveillance” with Ken Prewitt and Tom Keene.

Central banks “are seeing something in the functioning of the banking system that worries them,” El-Erian said.

--With assistance from Joshua Zumbrun in Washington, John Tucker in New York, Lily Nonomiya in Tokyo and Gavin Finch in London. Editors: Christopher Wellisz, Gail DeGeorge

To contact the reporters on this story: Scott Lanman in Washington at slanman@bloomberg.net; Jeff Black in Frankfurt at jblack25@bloomberg.net

To contact the editors responsible for this story: Chris Wellisz at cwellisz@bloomberg.net; Craig Stirling at cstirling1@bloomberg.net


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