Finotec News Archive - September 05 2007

BOE, ECB Act to Protect Economies From Higher Rate

Rodian Rahnayev
05 September 2007

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The Bank of England offered extra cash to financial institutions and the European Central Bank said it is ``ready to contribute'' as policy makers sought to shield economies from an increase in borrowing costs.

While the ECB provided emergency funds last month, this is the Bank of England's first attempt to lower the cost of credit. The collapse of the U.S. subprime mortgage market has made banks reluctant to lend to each other, boosting the rate banks charge to borrow in dollars for three months to the highest since 2001. Both central banks announce monthly interest-rate decisions tomorrow. ``The increase in funding rates, if it persists, could have adverse effects on companies and hurt the real economy,'' said Neil Mackinnon, chief economist at London-based hedge fund ECU Group Plc and a former U.K. Treasury official. ``Central banks are doing what they think is best, but I don't see any signs of rates coming back down until confidence revives.''

The U.K. central bank is responding to a 0.3 percentage-point increase in overnight lending rates in the past month. It will offer as much as 4.4 billion pounds ($8.9 billion) on Sept. 13 at the benchmark interest rate, currently at 5.75 percent, instead of its usual higher penalty rate. The ECB said that it may act tomorrow to help restore ``orderly conditions.'' The shortage of funds in global money markets is getting worse even after the ECB, the Federal Reserve and other central banks added more than $350 billion to the financial system since Aug. 9, said Tim Bond, head of global asset allocation at Barclays Capital. He spoke in an interview today.

The London interbank offered rate for three-month dollar loans increased to 5.72 percent yesterday, the highest since January 2001, from 5.70 percent yesterday and 5.36 percent at the end of July, the British Bankers Association said. The U.S. Federal Reserve, which on Aug. 17 unexpectedly lowered the rate at which it makes direct loans to banks, added $8.5 billion dollars to the banking system in a normal refinancing operation today. The overnight interbank lending rate matched the central bank's 5.25 percent target.

The overnight deposit rate for the 13 countries sharing the euro dropped to 4.15 percent, the lowest in two days, after the ECB's announcement. It had earlier risen to 4.68 percent from 4.50 percent yesterday. That's above the 4.62 percent rate reached on Aug. 9, when the ECB started to pump extra cash into the money market to smooth interbank lending.

In the U.K., the rate at which banks lend pounds to each other overnight declined to 5.91 percent after the Bank of England's announcement, from 6.11 percent yesterday, according to figures compiled by the British Bankers Association. The three- month rate was unchanged at 6.8 percent, the most since December 1998. The bank's goal is to keep the overnight rate close to its benchmark lending rate, currently 5.75 percent.

The Bank of England said it will pay interest on excess funds kept in commercial banks' accounts with it at the end of the monthly reserve period, a break with the usual practice of not paying interest on any extra money held in reserve. That may encourage banks to borrow from it even if they don't expect to use the money. Three-month spreads have risen ``significantly'' because of a shortage of liquidity in markets for asset-backed securities, which has also affected money markets, the bank said in a statement. ``The source of these problems does not, therefore, lie in a lack of central bank liquidity.''

Bank of England policy makers will keep the benchmark interest rate unchanged today, according to survey. Policy makers have raised the rate five times in quarter point steps in the past year.

Finotec Analysis Team
05 September 2007

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Today's Economic Events

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