ECB, BoE turn on funding taps to ease crunch

LONDON Tue Dec 18, 2007 10:42am EST

People walk past the Bank of England in central London November 9, 2007. REUTERS/Alessia Pierdomenico

People walk past the Bank of England in central London November 9, 2007.

Credit: Reuters/Alessia Pierdomenico

LONDON (Reuters) - The European Central Bank and Bank of England flooded money markets with funds on Tuesday as the UK central bank chief warned of a possible downward spiral in credit conditions.

The Bank of England (BoE) charged a minimum bid rate of 5.36 percent for 10 billion pounds of 3-month money, as part of a coordinated action with other central banks to ease market tensions by offering cash at favorable rates.

The money was taken up though demand was muted, despite its being offered at below official BoE lending rates, suggesting a less urgent need for funding than had been feared.

But Bank of England Governor Mervyn King said banks were still deeply concerned about the liquidity crunch.

"Banks themselves have been worried that the impact of their reluctance to lend will lead to a sharper slowdown in the United States," King told a parliamentary committee.

"That concern is a serious one because it does hold out the prospect that there will be a self-reinforcing downturn in credit and activity."

The ECB scrapped the usual upper limit on how much it lends to banks in Tuesday's offering of two-week money, to ensure lending rates stayed close to its target of 4 percent.

Banks clambered in, snapping up a hefty 348.6 billion euros ($500 billion) at a 4.21 percent lowest rate.

Two-week Euribor interbank rates fixed sharply lower in response while London interbank offered rates for three-month sterling also fell, on the back of the BoE auction.

The ECB offer was the first time it had said it would meet all banks' bids above a certain rate since its first liquidity injection on August 9, as the credit crunch blew up.

"They're throwing everything they can at the liquidity problem," said one trader.

On Monday, the ECB offered $20 billion of 28-day funds at auction as part of the joint plan by leading central banks to alleviate strains in the interbank lending market.

The Federal Reserve offered a similar amount, while the Swiss National Bank (SNB) offered up to $4 billion at a discount to the Fed's existing discount rate.

Results of those auctions are due on Wednesday.

Most experts say the joint action, whereby the Fed, SNB, ECB, BoE, Bank of Canada and others provide fresh short-term lending, is unlikely to solve the crisis alone.

U.S. subprime mortgages -- lent to people ill-equipped to pay them back -- were bundled up into complex financial products and sold on around the globe.

Only when uncertainty about where the exposure lies is resolved are commercial banks likely to lend money freely to each other again on the interbank market, which oils the global economy's wheels.

"Large banks are now awash with cash. The issue is not whether they have enough cash, it is whether they are inclined to lend," King said.

GOLDMAN SWERVED CRISIS

Investors are braced for key bank results this week, some expected to show further damage. But Goldman Sachs (GS.N) kicked off on Tuesday with record earnings per share.

Goldman said its fourth-quarter earnings rose as a timely bet against subprime mortgages and higher investment banking fees helped it sidestep the credit crunch.

The world's largest securities firm by market value said Q4 net income rose to $3.22 billion.

Morgan Stanley reports on Wednesday with Bear Stearns, already hard hit, following on Thursday.

Financial firms have to date written down more than $65 billion in credit-related losses. With official estimates of total losses from the subprime mortgage debacle around $300 billion, investors are braced for further shocks.

Britain deepened its involvement in stricken mortgage bank Northern Rock NRK.L, offering to guarantee more of its liabilities as the struggle to find a private sector acquirer for the business continues.

Northern Rock is being auctioned off after a funding crisis in September forced it to borrow 25 billion pounds from the Bank of England, but that process has been thrown into doubt, with several suitors withdrawing.

In Australia, shares in Centro Properties Group CNP.AX slumped another 69 percent on fears its exposure to the subprime crisis will sink the company, but analysts said other Australian property firms were unlikely to face similar problems.

Australia's central bank saw strong reasons for a rise in interest rates at its December policy meeting but held off because of the credit squeeze, minutes of the meeting showed.