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WSJE: Central Bankers Step Up Amid Credit Woes; ECB In Market Again

By By Joellen Perry, Greg Ip and Monica Houston-Waesch

Of THE WALL STREET JOURNAL EUROPE AND DOW JONES NEWSWIRES

FRANKFURT -(Dow Jones)- The world's central bankers say investors should bear the pain of their past excesses, but turmoil in credit markets is testing that hard line.

The European Central Bank, reacting to continued tension in world credit markets, on Friday moved for the second day in a row to inject liquidity into the European banking system.

The ECB added EUR61.05 billion to money markets at a weighted average allotment rate of 4.08%. Demand for the cash was strong, the ECB received 62 bids totaling EUR110.035 billion.

Euro-zone money market tensions aren't nearly as high as Thursday, when the euro-zone overnight lending rate shot above the ECB's 4% target to 4.7%. Now, the rate is around 4.12%, signalling markets are calmer. But such strong demand for the ECB's funds - Friday's total was just under the EUR69.3 billion the bank injected into the market on September 12, 2001 - reflect the fact that market players remain extremely nervous about just how widespread the credit crunch is.

The allotment matures on Monday, which could well prompt the ECB to again add liquidity if market conditions don't improve. But the more pressing question, say market participants, is whether the U.S. Federal Reserves again follows suit on Friday with more liquidity injections of its own.

Friday's ECB tender differs from yesterday's, when unlimited funds were offered at a guaranteed fixed 4% rate, as the money market overnight rates shot up to 4.7%.

"This liquidity-providing fine-tuning operation follows up on the operation conducted yesterday and aims to assure orderly conditions in the euro money market," the ECB said in a statement.

Friday's ECB tender expires in three days; many say the big question is what happens when it expires next week. If markets have calmed down further, the ECB may not need to inject more cash. But if not, the market may need more infusions - which would put the ECB's planned September interest-rate rise, to 4.25%, in doubt. The more liquidity the bank puts into the market, the less likely it is to restrict liquidity by raising interest rates.

"If this situation goes on much longer, it would seem perverse to raise rates in September," said Julian Callow, chief European econoimst with Barclays Capital in London.

Traders had expected the move as money market overnight rates were around 4.30% to 4.35% in early trade, above the ECB refinancing minimum bid rate of 4.00%.

Following the ECB's latest allotment, the overnight rate is around 5.10% - 5.15% in midday trade.

Friday's tender replaces the ECB's infusion of an unscheduled EUR94.84 billion in one-day emergency funds on Thursday, an operation which came due Friday.

Failing to roll over the earlier tender risked tightening money markets further.

"Markets are currently facing a liquidity crisis, the beginning of a potential credit crunch scenario. Fundamentals do not matter in such a situation, and hence markets will ignore lonely voices shouting for a focus on healthy balance sheets and low default rates," said analysts at UniCredit in a note to clients early Friday morning.

Now European traders are also hoping for a stronger liquidity injection by the Federal Reserve Friday. Brokers and analysts say it is still very difficult for European banks without U.S. operations that have direct access to the Fed to buy dollars.

Some dollar overnight lending rates jumped to 6.20%-6.30% early Friday from around 5.50% in U.S. dealings - well above the Fed's target of 5.25%.

"The Fed must do something, the overnight dollar rate is now at 5.50% to 6%" said a money trader at a cooperative sector bank in Frankfurt. "If the Fed doesn't act, that rate could go higher."

The Federal Reserve Thursday followed the ECB's earlier move by adding a larger-than-normal $24 billion in temporary reserves to the U.S. banking system. In Asia, the central banks of Japan, Hong Kong and Australia all also pitched in with liquidity injections into their banking systems.

The liquidity injections into the money market come after a series of broad declines in world financial markets as concern of a credit crisis grew.

In Japan, stocks plunged Friday, with the Nikkei Stock Average of 225 issues shedding 2.37% to close at 16.764.09 points. The Bank of Japan funneled 1 trillion yen into money markets to curb rises in the key overnight rate.

In Thursday U.S. trading, the Dow Jones industrial average and the Standard & Poor's 500 index suffered their biggest one-day plunges since Feb. 27. The DJIA slumped 387.18 points, or 2.8%, to 13270.68, while the S&P 500 lost 44.4 points, or 3% to 1453.09.

The main trigger for the latest market turmoil is French bank BNP Paribas (BNPQY), which Thursday said that it suspended redemptions in and the calculation of the net asset value of three of its funds.

-By Monica Houston-Waesch, Dow Jones Newswires; +49 69 29 725 520; nikki.houston@dowjones.com

(Emesa Bartha and Adam Bradbery contributed to this item)

(END) Dow Jones Newswires

August 10, 2007 08:44 ET (12:44 GMT)


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