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Europe Central Banks Race To Smooth Bank Liquidity Wed

By Nina Koeppen and Natasha Brereton

Of DOW JONES NEWSWIRES

FRANKFURT (Dow Jones)--Central banks in Europe on Wednesday worked hard to smooth sharp distortions in interbank money markets, with the European Central Bank and the Bank of England injecting further dollar funds.

The ECB said it would offer up to $50 billion dollars in overnight funds to cash-strapped banks in a repurchase operation Wednesday.

Separately, the BoE said that it would give out an extra $30 billion in dollar funds maturing Oct. 7 in a similar tender.

The moves highlight increasingly close cooperation between the world's major central banks to offset a deeply-rooted crisis of confidence that has kept banks from lending to each other because of perceived default risk.

"Central banks can address the problem of liquidity, but they cannot address the problem of solvency and trust among banks," said Stephane Deo, an economist at UBS.

Banks' general distrust was also highlighted in the usage of the ECB and BOE's overnight facilities.

One or more financial institutions parked a staggering EUR102.811 billion overnight in the ECB's deposit facility, which pays a low rate of 3.25%, data from the central bank showed Wednesday.

The significance is that European banks would rather park funds at the central bank at a lower rate than lend to other banks at a higher rate.

By comparison, overnight euro money market rates in the interbank market are currently trading around 4.40% - above the ECB's 4.25% key policy rate.

A bank or banks also lodged funds worth GBP7.04 billion with the BOE's standing deposit facility Tuesday, which pays interest of 100 basis points below bank rate. The U.K. bank rate is currently 5.0%.

Separately, one or more banks borrowed a total of EUR15.946 billion from the ECB's marginal lending facility overnight that costs 5.25%, a penalty rate of 100 basis points above the ECB's key policy rate.

But the flurry of liquidity measures failed to stop the steady climb in longer-term money market rates in the euro-zone. One-month money market rates rose to around 5.15% from 5.0% late Tuesday.

Massive market distortions also became apparent when the ECB and the BOE both said Wednesday that they would drain excessive short-term liquidity.

The ECB said it will drain up to EUR200 billion from the money market at a fixed rate of 4.25% later Wednesday. And the BOE offered to drain up to GBP10 billion of reserves in a one-day repurchase agreement.

"This follows the settlement yesterday of Monday's extended long-term repo operation which provided GBP40 billion of reserves," the BOE said in a statement.

In the U.K., the injection of an additional $30 billion in one-week dollar liquidity by the BOE comes after a sharp rise in the rate that banks are willing to pay for central bank dollar funds Tuesday, to 5.211% from 2.408% Monday. The dollar overnight London interbank offered rate fixed at 6.875% Tuesday, up very sharply from 2.56875% Monday.

The decision to act follows the announcement Monday of an increase in the size of the BOE's swap facility with the U.S. Federal Reserve to $80 billion from $40 billion, and brings its total provision of dollar liquidity to $70 billion.

(Emese Bartha contributed to this story.)

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(END) Dow Jones Newswires

October 01, 2008 05:39 ET (09:39 GMT)


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