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Nov. 30 (Bloomberg) -- The Federal Reserve’s agreement with five other central banks to provide cheaper dollar funding for European banks may fail to ease strains in financial markets if the sovereign debt crisis worsens, according to UBS AG.
While today’s announcement boosted the euro and stocks, the optimism may prove short-lived if European leaders fail to come up with measures at a Dec. 9 summit to help indebted nations, London-based strategists Geoffrey Yu and Chris Walker wrote today in an e-mailed note.
“In the event of extremely negative outcomes out of the eurozone, it is likely that funding stress will escalate regardless of the existence of the swap lines,” Yu and Walker wrote. “If the summit fails to deliver, the euro’s slide will resume and the selloff in risk would prove as dramatic as we have seen this year, if not more.”
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, Bank of Canada, Bank of England, Bank of Japan, and Swiss National Bank.
The cost for European banks to fund in dollars rose to a three-year high today as concerns about a possible breakup of the euro area increased after European finance ministers meeting yesterday in Brussels said they had failed to increase the firepower of the region’s bailout fund.
If the European situation worsens, “banks will choose to exercise maximum aversion to counterparty risk and drag the eurodollar down along in the process,” Yu and Walker wrote.
--Editors: Nicholas Reynolds, Mark McCord
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