The European Central Bank has promised to supply the money markets with an extra €30bn (£22bn) in one-week funds, in another indication that the credit crisis is far from over. The ECB sold €178bn of these funds to eurozone financial institutions, compared with the €148bn it had previously said the banks would need for routine business.
Such an injection of liquidity is consistent with the ECB's approach since the credit squeeze started in the summer. The move follows the ECB's warning last week that tensions in the credit markets were "re-emerging".
Addressing a forum in Tokyo yesterday, the Governor of the Bank of France and ECB Governing body member, Christian Noyer, sought to reassure the markets. He quoted estimates of around $250bn (£120bn) for the direct cost of defaults on US mortgages. "It is significant but bearable, especially starting from a point of very favourable economic conditions and high profitability," he said.
However, such soothing words may not fit easily with the ECB's remit, which is geared to limiting eurozone inflation to 2 per cent. Last month, the eurozone inflation rate hit a two-year high of 2.6 per cent, and the latest data from Germany points to further acceleration in November.
The ECB is not alone in trying to prevent the credit markets from seizing up again and giving a fresh twist to the credit squeeze, symptomised by high short to medium-term interest rates in the money markets. Yesterday, three-month euro rates rose to 4.72 per cent, unusually far above the ECB's 4.0 per cent policy rate; this was their biggest single-day rise since August, and the equivalent dollar rates were at a one-month peak.
In response to these worrying hikes, the US Federal Reserve has announced that it will offer $8bn in capital to US banks, while last night an independent member of the Bank of England's Monetary Policy Committee, Andrew Sentance, warned that "there are indications of a tightening of the availability of credit, particularly to more risky borrowers, leading to worries that there will be a knock-on effect constraining consumer spending and business investment, not just in the UK but across Europe, North America and other developed countries".
The New York Federal Reserve announced on Monday it was implementing several measures to increase liquidity in the parched credit markets. The Fed and ECB actions are designed to quell fears that there will not be enough money available to the markets, as financial institutions "hoard cash" and refuse to lend to each other, actions that threaten to slow investment and growth in the "real economy", and, indeed leave sub-prime borrowers in the US in even more danger of defaulting, so triggering more bank write-downs. For its part, on 8 November the Bank of England announced a similar move -- an increase in the target level of reserves held at the Bank by financial institutions to £21.2bn, the highest since June 2006.