Central banks patrol markets amid credit fears

By Krista Hughes and Randall Palmer

FRANKFURT/OTTAWA (Reuters) - Central banks in Europe and Japan on Wednesday mopped up cash poured into money markets to quell a global credit storm, but in Canada and the United States there were more measures to shore up liquidity.

The Bank of Canada stepped in after a day on the sidelines of the money market, and the Federal Reserve added $7 billion in temporary reserves as losses in the U.S. subprime mortgage market sent Wall Street stocks slumping again.

For the first time since it began pumping extra cash into Europe's money markets on Thursday, the European Central Bank gave no extra short-term money to keep the financial system operating smoothly. Central banks in Japan and Switzerland actively drained cash from their local markets after injections of liquidity in the past week.

However, emerging market Asian central banks took steps to smooth trade in the region's currency markets as ongoing credit fears hit stocks and sent the yen to a 4-1/2-month high, as investors unwound carry trades involving borrowing in yen to invest in higher yielding securities elsewhere.

Analysts warned that the credit squeeze and liquidity problems were spreading.

"The turmoil in financial markets continues with a greater contagion in Asia, emerging markets and investment grade credit," Tullett Prebon G7 economist Lena Komileva said.

Signs of credit bottlenecks have led investors to scale back expectations for interest-rate increases or, in the case of the Fed, have raised expectations for an ease.

Interest rate futures prices suggest traders see a certainty that the U.S. central bank will lower borrowing costs by at least a quarter-percentage point at its next meeting on September 18, and a chance it may even cut rates sooner.

St. Louis Federal Reserve Bank President William Poole, however, said there was no need for an emergency rate cut and said that so far it appeared the economy was faring fine.

"It's premature to say that this upset in the market is changing the course of the economy in any fundamental way," he said in an interview with Bloomberg. "Obviously, there could be an impact, but we have to rely on some real evidence."

STOCKS STUMBLE

The Dow Jones Industrial Average shed nearly 170 points, or 1.3 percent, to 12,861, its first close below 13,000 since April 24, as investors wondered who would be the next victim as credit dries up for all but the best of borrowers.

The Fed's action was modest compared with the $38 billion it poured into markets on Friday, the largest amount injected since just after the September 11, 2001, attacks. But dealers said it was a reminder the Fed remained alert to market needs.

The Bank of Canada injected C$350 million ($330 million) of repurchase funds and left the market flush with cash at the end of the day. It left a C$500 million balance in the Large Value Transfer System, which allows easy balance settlements by banks, up from the normal C$25 million. It said it plans to do the same on Thursday.

"This is helpful and may alleviate some of the pressure. It may not be the end of the nervousness that we see, but it's a positive step in the right direction," said Mark Chandler, fixed income strategist at RBC Capital Markets.