Bank of England Drains Bank Reserves to Calm Markets

By Jennifer Ryan

Oct. 6 (Bloomberg) -- The Bank of England will drain excess bank reserves from money markets in order to bring overnight interest rates in line with its benchmark and quell financial- market tensions.

The bank will sell sterling bills maturing in one week or less at the benchmark rate of 5 percent, the Bank of England said in a statement today. The operations aim to ``stabilize overnight market rates broadly in line with the Monetary Policy Committee's bank rate'' and will be conducted as needed by market conditions.

Reserves that U.K. financial institutions keep at the Bank of England jumped by 7.6 billion pounds ($13 billion) in September from the previous month, the biggest increase since the current money market system began in May 2006, data showed today. Excess short-term funds have made it harder for the bank to control overnight rates after the financial crisis intensified.

``The operations are to mop up extra liquidity at the very short end, and say nothing about what they'll have to do tomorrow or next week,'' said Matthew Sharratt, an economist at Bank of America Corp. in London. ``It doesn't say anything about the overall need for liquidity and the cash squeeze going forward.''

Today's announcement also follows unprecedented use of the central bank's standing deposit facility. Banks used it nine times in the past three weeks to deposit extra funds.

The overnight lending rate rose to 5.08 percent today, compared with 5 percent on Oct. 3. The reading climbed as high as 6.79 percent Sept. 16, and fell as low as 4.5 percent on Sept. 23.

The changes compare with an average from April to August of 5.08 percent, with the biggest deviation a single jump to 5.32 percent on June 30.

Reserves Target

The bank also said today it tightened the range around the reserves target for financial institutions to 40 percent from the 60 percent range set on Oct. 1.

Today's announcement is in line with arrangements established in the bank's so-called ``red book'' on money market operations.

``In the event of any major disruption during a maintenance period,'' the bank may ``increase the supply of central bank money to the market through regular or exceptional open market operations'' and ``could also raise reserves targets, and/or widen the range around them,'' according to the rules in the book.

The Bank of England's announcement today follows its offer of emergency funds with longer maturities for the past month as part of a global coordinated central bank effort to calm markets. Last week the bank extended the range of collateral it accepts for three-month auctions and said it will offer 40 billion pounds of funds under the new rules, starting tomorrow.

To contact the reporter on this story: Jennifer Ryan in London at Jryan13@bloomberg.net