19 December 2007

FT: Investors stunned by ECB’s €350bn

Short-term market interest rates in the eurozone plunged at their fastest rate for more than a decade on Tuesday after the European Central Bank stunned investors by pumping a record €348.6bn worth of funds into the markets.

The size of the injection – which was intended to calm the markets over the critical year-end period – was twice as big as the ECB had indicated would have been needed in normal circumstances.

 “The sheer magnitude of the operation caught the market off guard,” said Win Thin, Brown Brothers Harriman’s senior currency strategist, who said there was talk that banks from the US and UK might have taken funds at lower rates than they could secure from their own markets.

The emergency operation, which followed last week’s co-ordinated effort by western central banks to ease pressures in the financial system, prompted the two-week euro London interbank offered rate (Libor) to fall a record 54 basis points to 4.40 per cent. The one-month and three-month rates recorded their biggest falls for nearly six years.

However, analysts warned further big declines were unlikely, given that tensions remained high in the financial world. There are also concerns in the market that the ECB may come under pressure to mop up any excessive liquidity to prevent the return of inflationary pressures.

Separately, the Bank of England also sought to offset market tensions by conducting the first of its long-term refinancing operations, auctioning £10bn (€14bn) in three-month funds at a minimum rate of 5.36 per cent – 14 basis points below the 5.5 per cent base rate. Three-month sterling Libor fell for a fourth successive session.

The US Federal Reserve will on Wednesday publish the results of an exceptional $20bn auction it performed on Monday to inject funding into the US financial system.

The unprecedented series of co-ordinated central bank actions have been sparked by signs of rising tensions in global money markets, which some analysts attribute to the fact that private sector banks typically hoard funds at the end of the calendar year to show strong balance sheets for reporting purposes.

However, a number of analysts fear banks are hoarding funds because they fear further big credit losses next year.

In another sign of mounting pressures, the ECB revealed that its emergency “marginal lending facility” – which attracts a penal interest rate – had been tapped for €2.44bn on Monday. That suggests some European banks still face considerable difficulties as a result of the global credit squeeze.

By Ralph Atkins in Frankfurt and Dave Shellock and Gillian Tett in London

© Graham Bishop