Europe's Central Banks Intensify Effort to Jolt Market to Life

By Simon Kennedy and Christian Vits

Oct. 16 (Bloomberg) -- Europe's central banks are intensifying efforts to jolt credit markets back to life.

The European Central Bank yesterday said it will accept lower-rated securities as collateral when lending to banks and offer them as many euros as they want over the next six months. The Swiss central bank said it will conduct currency swaps with the ECB. The Bank of England will unveil plans to revamp its market operations at 11 a.m. in London today.

``Central banks are throwing everything they can at the credit markets to get them working again,'' said Win Thin, an economist at Brown Brothers Harriman & Co.

Policy makers are becoming more creative as they bid to end a 14-month credit freeze which has left their economies on the edge of recession. While the cost of borrowing euros has fallen, banks continue to deposit record amounts of cash with the ECB, a sign they remain reluctant to lend to each other.

Throwing open the door to what it will accept when lending, the ECB will now exchange cash for debt securities denominated in dollars, pounds and yen as well as euros. They must also be issued in the 15-nation bloc. The changes take effect imminently and stay in force until the end of next year.

``Essentially, they are moving to provide financing in a much more substantial way to the banking system,'' said Julian Callow, chief European economist at Barclays Capital in London.

The rating on the bonds accepted in market operations was cut to BBB- from A-, with the exception of asset-backed securities. The ECB also said it's expanding its program of offering banks unlimited cash to all ``longer-term'' operations. Previously this only applied to its weekly operations.

Tackling Crisis

The Bank of England is also stepping up its efforts amid criticism it hasn't done enough to tackle the crisis and plans to introduce a discount window facility. Kenneth Broux, economist at Lloyds TSB Group Plc, said it may follow the ECB in widening the collateral and credit ratings it will accept for loans.

``Central banks are moving in coordinated fashion, which is good news, and there's room for the Bank of England to follow,'' he said.

The shift follows a redoubling of efforts by policy makers to thaw money markets. In the past week, the ECB said it will offer banks as many euros and dollars as they want and joined the Bank of England and other counterparts in a united round of interest-rate cuts. Governments have also established programs to recapitalize banks and guarantee bank lending.

The Frankfurt-based central bank last week cut its main rate to 3.75 percent from 4.25 percent.

Rate Cut

``The ECB is trying to ensure that at least a significant share of the 50 basis-point rate cut which it consented on Oct. 8 will be effectively passed to the rest of the economy,'' said Gilles Moec, an economist at Bank of America Corp. in London and a former official at the French central bank.

Policy makers have so far had some success in reducing money market rates with the cost of borrowing euros over three months falling for a fifth day yesterday to 5.175 percent.

Even so, that remains well above the bank's 3.75 percent refinancing rate. Banks remain skeptical of lending to each other, depositing a record 196.1 billion euros ($267 billion) with the ECB two days ago rather than storing it elsewhere.

``Despite some positive reaction, the interbank market has still not come to life,'' said Carsten Brzeski, an economist at ING Group in Brussels. ``The only question remains whether the ECB has any ammunition left.''

President Jean-Claude Trichet said Oct. 12 that the ECB lacks the legal powers to immediately follow the Federal Reserve in opening a facility to buy commercial paper.

Running Short

The ECB may have acted in part because some banks were running short of acceptable collateral, according to Moec. Dropping the cap on cash over a longer time should also help the economy by reducing 3-month and 6-month lending rates which serve as benchmarks for some loans to companies and consumers, he said.

``It's a very significant step,'' said Moec. ``They are acting to influence both the price of money and the quantity of money out there.''

In an effort to make it easier for banks in Europe to access dollar liquidity, the ECB said it will start offering dollars through foreign-exchange swaps. Separately, the ECB and the Swiss National Bank announced they will conduct seven-day currency swaps to lower money-market rates for Swiss francs.

The ECB's increased generosity marks a reversal from Sept. 4 when it announced plans to tighten its lending rules. The bankruptcy of Lehman Brothers Holdings Inc. on Sept. 14 precipitated the latest chapter of the credit crisis, causing banks to stop lending to each other out of concern they may not get their money back.

``The expansion of the eligibility criteria announced today will be combined with vigilant monitoring of the use of the framework,'' the ECB said.

To contact the reporter on this story: Simon Kennedy in Paris at skennedy4@bloomberg.netChristian Vits in Frankfurt at cvits@bloomberg.net