ECB, BOE Join Fed in Soothing Markets After Lehman

By John Fraher
More Photos/Details

Sept. 15 (Bloomberg) -- The European Central Bank and the Bank of England joined the Federal Reserve in taking action to soothe financial markets spooked by Lehman Brothers Holdings Inc.'s bankruptcy filing.

The ECB said it awarded banks 30 billion euros ($43 billion) in a one-day money-market auction that was more than three times oversubscribed. The Bank of England loaned banks 5 billion pounds ($9 billion) for three days. Earlier, the Federal Reserve widened the collateral it accepts for loans to securities firms.

Stocks plunged and the cost of borrowing dollars surged after Lehman became the latest victim of a yearlong credit squeeze. Financial institutions worldwide have reported more than $500 billion in losses and writedowns and the credit-market turmoil has erased $11 trillion from global stocks in the past year.

``It remains to be seen whether today's operation will be sufficient to restore market confidence,'' said Jacques Cailloux, chief euro-area economist at Royal Bank of Scotland Group Plc. ``The ECB will likely wait for the U.S. open to consider more aggressive action. Key will be how credit and equity markets develop in the coming days.''

The ECB said it injected the funds at a marginal rate of 4.30 percent. The Swiss central bank offered liquidity through its overnight facility for the first time since Feb. 22.

``We have to be extraordinarily alert,'' ECB President Jean-Claude Trichet told reporters in Frankfurt today. ``We have said it in recent weeks'' that ``it's an ongoing market correction'' with ``episodes of a high level of volatility.''

China, Australia

China cut interest rates for the first time in six years and the Reserve Bank of Australia added A$2.1 billion ($1.7 billion) through so-called repurchase agreements today. The Bank of Japan, whose markets were closed today for a holiday, said it was monitoring the situation.

``The job of central banks now is to ensure there is sufficient liquidity in the system and they're assuring market participants of that,'' said Thomas Mayer, co-chief economist at Deutsche Bank AG in London.

The Fed also yesterday boosted its program for lending Treasuries to bond dealers by $25 billion, bringing it to $200 billion. At the same time, a group of 10 banks that includes JPMorgan Chase & Co., Goldman Sachs Group Inc. and Citigroup Inc. formed a $70 billion fund to ensure market liquidity.

Yields on two-year Treasury notes fell below 2 percent for the first time since April on speculation the Fed will need to cut rates. U.S. index futures dropped, with December contracts on the Standard & Poor's 500 Index falling 3.3 percent. The cost of borrowing dollars overnight jumped to 3.11 percent today from 2.15 percent.

No Rate Cut Yet

The ECB and the Bank of England may nevertheless hold off cutting rates right away as they seek to curb inflation. The ECB has spent much of the past year arguing that it can use its money market operations to tackle the credit crisis and doesn't need to resort to rate cuts.

``Rate cuts are only likely to be forthcoming if financial markets melt down in the coming days or weeks,'' said David Mackie, chief European economist at JPMorgan Chase & Co. ``For the time being, European policy makers look like they will continue to hold the line on the separation of powers. At some point though, that line could be reached.''

Trichet said in his speech today that ``price stability is a prerequisite for financial stability, a very important objective at the current juncture.''

The ECB was the first central bank to respond when credit markets first seized up in August last year by offering financial institutions unlimited funds. Banks today asked for 90.3 billion euros in funds, close to the 94.8 billion euros bid on the first day of the crisis last year.

``The results of the one-day refinancing bill auction show that demand for liquidity is currently very high and highlights how fragile the current situation is,'' said Cailloux. ``The ECB will likely take note that the financial system remains starved of cash and that it might thus be forced to step in again.''

To contact the reporter on this story: John Fraher in London at jfraher@bloomberg.net