Central Bank Measures to Address Elevated Pressures in Short-term Funding Markets

Today, the Bank of Canada, the Bank of England, the European Central Bank, the Federal Reserve, and the Swiss National Bank are announcing measures designed to address elevated pressures in short-term funding markets.

Bank of England Actions

The Bank of England has already scheduled long-term repo open market operations (OMOs) on 18 December and 15 January. In those operations reserves will, as usual, be offered at 3, 6, 9 and 12-month maturities against the Bank’s published list of eligible collateral. But the total amount of reserves offered at the 3-month maturity will be expanded and the range of collateral accepted for funds advanced at this maturity will be widened.

The total size of reserves offered in the operations on 18 December and on 15 January will be raised from £2.85 billion to £11.35 billion, of which £10bn will be offered at the 3-month maturity.

The Bank will accept a wider range of high quality securities as collateral against funds advanced at the 3-month maturity. The additional categories of eligible collateral are:

• Bonds issued by sovereigns rated Aa3/AA- or above (in addition to those currently eligible), subject to settlement constraints.
• Bonds issued by G10 government agencies guaranteed by national governments, rated AAA.
• Conventional debt security issues of the Federal Home Loan Mortgage Corporation, the Federal National Mortgage Corporation and the Federal Home Loan Banking system, rated AAA.
• AAA-rated tranches of UK, US and EEA asset-backed securities (ABS) backed by credit cards; and AAA-rated tranches of UK and EEA prime residential mortgage-backed securities (RMBS).
• Covered bonds rated AAA.

Securities must be denominated in sterling, euro, US dollars, Australian dollars, Canadian dollars, Swedish krona, Swiss francs, and, in the case of Japanese Government Bonds only, yen; and must be capable of being delivered via a settlement channel specified by the Bank.

There will be no further changes to the scheduled operations on 18 December and 15 January. As usual, those eligible to bid in the operations will be the Bank’s OMO counterparties and the operations will be conducted as variable rate tenders with funds offered to successful bidders at the rate(s) that they tender.

Consistent with the Bank’s objective of keeping overnight market interest rates in line with Bank Rate, the Bank intends to offset the additional reserves taken up in the long-term repo operations in December and January in its other operations.

The Bank will review whether to make any changes to operations scheduled after January in the light of market conditions at the time.

The Bank will announce further operational details, including details of collateral and settlement arrangements, in a Market Notice on Friday 14 December.

Central banks step in to attack credit crisis

The world’s central banks on Wednesday unleashed a co-ordinated assault on the liquidity squeeze in global capital markets.

The Federal Reserve, European Central Bank, Bank of England, Bank of Canada and the Swiss National Bank all announced measures to attack the liquidity crisis.

The Fed said it was creating a temporary credit auction facility, as revealed in Wednesday’s Financial Times, and entering into foreign exchange swap agreements with the ECB and the Swiss to tackle the shortage of dollar funds in Europe.

The move comes after several weeks of mounting tension in the global money markets, due to a combination of normal, year-end funding pressures and deepening gloom among banks about the impact of the losses on subprime-linked securities.

Until recently, some bankers had hoped that these money market pressures would be short-lived. However, in recent days some of the money market indicators have started to move in ways that suggest banks are now worried that funding problems will last into the New Year, or even the summer. This appears to have prompted the central banks to launch their joint action – a step that is unprecedented in terms of the degree of co-ordination that it implies between the leading central banks.

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The issue of co-ordination between central banks has become particularly important in recent months, since the most severe funding problems have often occurred in the dollar markets – but many of the victims of these pressures have been European institutions, which have not always had access to the dollar market on the same terms as US banks.

This pattern prompted suggestions in the summer that the ECB should conduct a currency swap with the Fed, but this was rejected by the ECB at this time as an unnecessary move.

“The actions demonstrate that central banks are working together to try to forestall any prospective sharp tightening of credit conditions,” a Bank of England spokesman said.

Wall Street welcomed the news. The Dow Jones Industrial Average opened up 204 points at 13,637. The yen fell sharply against a range of currencies as traders bet that the banks’ move would help raise risk appetite and lead to a rejuvenation of the carry trade.

US Treasuries fell and yields rose as investors fled havens and were poised to move back into equities.

In Europe, the FTSE 100 in London, which at one stage in the morning had been down more than 100 points, turned to the black with a gain of 35 points. Banking stocks in particular saw fresh demand, reversing earlier losses.

As part of the measures, the Fed will auction term funds to depository institutions against a wide variety of collateral that can be used to secure loans at the discount window.

The first auction under the programme will be $20bn in 28-day term funds on Monday, settling December 20, with a second auction of $20bn in 35-day funds scheduled for December 20, settling on December 27. Subsequent auctions are scheduled on January 14 and January 28.

Ian Shepherdson, chief US economist at High Frequency Economics, said: “We think these measures are a step in the right direction, but there is simply no way to know for sure how effective they will be. The big question, though, is why the Fed did not make this announcement yesterday, instead of allowing the markets to be hugely disappointed by their actions. Much of the pain yesterday could have been avoided if the Fed had simply said that it would make an announcement about market conditions today.“

However, a senior Fed official said: “This was a global effort among a number of central banks. We wanted to announce that together. We could not have announced yesterday as Europe was closed.”

“Market reaction yesterday had nothing to do with today’s announcement,” the official added. “This has been in the works for a while. The market response was not a factor.”

The official said: “This is not about particular financial institutions with particular problems. This is about market functioning.”

The official added that “this facility will accept a wide range of collateral – the same range as is available at the discount window,” saying “there is no reason to believe there would be stigma associated with the use of this facility.”