Central Banks Cut Cost of Borrowing Dollars to Ease Crisis

Six central banks led by the Federal Reserve made it cheaper for banks to borrow dollars in emergencies in a global effort to ease Europe’s sovereign-debt crisis.

Stocks rallied, driving the Dow Jones Industrial Average up the most since March 2009, commodities surged and yields on most European debt fell on the show of force from central banks aimed at easing strains in financial markets. The cost for European banks to borrow dollars dropped from the highest in three years, tempering concerns about the euro’s worsening crisis after leaders said they’d failed to boost the region’s bailout fund as much as planned.

“It’s supportive but not necessarily a game changer,” said Michelle Girard, senior U.S. economist at RBS Securities Inc. in Stamford, Connecticut. “The impact is more psychological than anything else” as investors take heart from policy makers’ coordination, Girard said.

The premium banks pay to borrow dollars overnight from central banks will fall by half a percentage point to 50 basis points, the Fed said today in a statement in Washington. The so-called dollar swap lines will be extended by six months to Feb. 1, 2013. The Fed coordinated the move with the European Central Bank and the central banks of Canada, Switzerland, Japan and the U.K.

The six central banks also agreed to create temporary bilateral swap programs so funding can be provided in any of the currencies “should market conditions so warrant.” Those swap lines were also authorized through Feb. 1, 2013.

Starting December

The swap lines were previously set to expire Aug. 1, 2012. The new pricing will be applied to operations starting on Dec. 5. Seven-day loans would carry an interest rate of about 0.58 percent, down from 1.08 percent, based on the current one-week overnight index swap rate of 0.08 percent. OIS is a measure of expectations for the benchmark federal funds rate.

“This was in response to increased tension in global financial markets,” Bank of Japan Governor Masaaki Shirakawa said at a press conference in Tokyo today. “Coordinated action will give markets a sense of security.”

The action wasn’t aimed at supporting any specific financial institution, Canadian Finance Minister Jim Flaherty said in a Bloomberg Television interview in New York.

The Dow jumped 490.05 points, or 4.2 percent, to 12,045.68 at 4 p.m. in New York, and the Stoxx Europe 600 Index earlier surged 3.6 percent. The euro strengthened to $1.3444 from $1.3317 late yesterday. The yield on the 10-year Treasury note climbed to 2.08 percent from 1.99 percent.

Game Changer?

“When there’s concerted action by central banks, it’s definitely good,” said Jens Sondergaard, senior European economist at Nomura International Plc in London. “But are liquidity injections a game changer when the heart of the problem is in European sovereign debt markets?”

European banks gained, with Barclays Plc climbing as much as 9.4 percent in London trading. Deutsche Bank rose as much as 7.3 percent in Frankfurt, while BNP Paribas SA and Credit Agricole SA gained in Paris.

Today’s move echoes coordinated actions from the financial panic starting in 2007 to create and expand the currency-swap lines, whose use peaked at about $583 billion in December 2008. The central banks also jointly lowered their benchmark interest rates in October 2008.

Fed policy makers voted 9-1 for the swap action in a Nov. 28 videoconference, with Richmond Fed President Jeffrey Lacker dissenting, Michelle Smith, a Fed spokeswoman, said in an e-mail. Lacker voted in place of Philadelphia Fed President Charles Plosser, who was unavailable for the meeting, Smith said. Laura Fortunato, a spokeswoman for Lacker at the Richmond Fed, didn’t immediately respond to a request for comment.

No Current Difficulties

The Fed said U.S. financial companies “currently do not face difficulty obtaining liquidity in short-term funding markets.”

“However, were conditions to deteriorate, the Federal Reserve has a range of tools available to provide an effective liquidity backstop for such institutions and is prepared to use these tools as needed to support financial stability and to promote the extension of credit to U.S. households and businesses,” the central bank said in the statement.

U.S. House Financial Services Committee Chairman Spencer Bachus, an Alabama Republican, said in a statement that the move “is a recognition of the interconnected nature of the global economy” and that it’s in America’s interest to see Europe recover. At the same time, the action “should not and cannot absolve European policymakers from the need to resolve their own problems,” Bachus said.

China Move

Two hours before the Fed announcement, China cut the amount of cash that the nation’s banks must set aside as reserves for the first time since 2008. The level for the biggest lenders falls to 21 percent from a record 21.5 percent, based on past statements.

While today’s move by the six central banks is likely to ease tensions in money markets, it falls short of some calls for the ECB to step up and act as lender of last resort for the governments of the 17-member euro area and buy unlimited amounts of government bonds. Germany, Europe’s largest economy, has resisted the idea, arguing it isn’t the ECB’s job to do so and would only be a temporary fix.

The ECB unexpectedly cut its benchmark interest rate Nov. 3 by 25 basis points to 1.25 percent as the turmoil threatened to drag the euro area into recession. ECB policy makers next meet Dec. 8, while Fed officials gather Dec. 13.

Seven-Day Refinancing

Yesterday, the ECB allotted the most to banks in its regular seven-day refinancing operation in more than two years, lending 265.5 billion euros ($357.5 billion). The ECB offers unlimited funding to euro-area banks against eligible collateral.

“The purpose of these actions is to ease strains in financial markets and thereby mitigate the effects of such strains on the supply of credit to households and businesses and so help foster economic activity,” the Fed statement said.

Under the dollar liquidity-swap program, the Fed lends dollars to the ECB and other central banks in exchange for currencies including euros. The central banks lend dollars to commercial banks in their jurisdictions through an auction process.

The swap arrangements were revived in May 2010 when the debt crisis in Europe worsened. The Fed three months earlier had closed all swap lines opened during the financial crisis triggered by the subprime-mortgage meltdown in 2007.

Dollar Tender

European lenders asked for a total of $395 million in the ECB’s 84-day dollar tender conducted in coordination with the Fed on Nov. 9. In the first offering on Oct. 12, the ECB lent six banks $1.35 billion for three months. The next three-month loan will be offered on Dec. 7.

The coordinated action “lowers the cost of emergency funding and increases the scope,” Mohamed El-Erian, chief executive officer, of Pacific Investment Management Co. said in a radio interview today on “Bloomberg Surveillance” with Ken Prewitt and Tom Keene.

Central banks “are seeing something in the functioning of the banking system that worries them,” El-Erian said.