Fed boosts auction size in surprise action

By Mark Felsenthal

WASHINGTON (Reuters) - The Federal Reserve on Friday announced emergency measures to add $200 billion into the banking system in a bid to ease persistent liquidity strains that are leading to a global credit freeze.

The Fed said it would increase the size of its two term auctions of short-term funding to banks this month to $100 billion from the $60 billion previously announced. It also would start a series of term repurchase transactions with the primary dealers that trade securities directly with the Fed, expected to be worth a total of $100 billion.

The two measures are intended to "address heightened liquidity pressures in term funding markets," the Fed said in a surprise announcement.

The move coincided with unexpectedly somber news that U.S. employers cut 63,000 jobs in February, the second consecutive month of job losses. Senior Fed staff said their announcement was not related to the jobs report but rather a reaction to a broad recognition that financial market deterioration had accelerated in recent days.

"HEADWINDS" FOR THE FED

As the Fed sought to ease financial strains with liquidity measures, Fed officials highlighted the simultaneous difficulty the central bank faces in reviving the sluggish economy with interest rate cuts.

"In the current situation, monetary stimulus is facing significant headwinds ... In these circumstances, a central bank may have to ease policy more in order to achieve its desired effect," Kansas City Fed President Thomas Hoenig said in a speech in Rio de Janeiro.

But he warned there will be a buildup of inflationary pressures if rates stay too low for too long.

The dollar rebounded from record lows as the liquidity moves fueled speculation the Fed might be more restrained in cutting interest rates after February's job losses, and short-term Treasuries prices fell.

However, recession warning bells sounded by the bleak employment report sent stocks to their lowest close in 19 months, and long-maturity Treasury prices rose.

The Fed will aim to keep the Fed funds rate around its target despite the expanded auctions, senior central bank staff told reporters. They spoke on condition of anonymity and that they not be quoted directly.

The Fed unveiled its Term Auction Facility late last year to provide liquidity directly to the banking sector without compelling banks to access the Fed's discount window. Repurchase agreements are used routinely by the Fed to manage day-to-day liquidity and allow the Fed to inject liquidity directly to the 20 primary dealers.

In its statement on Friday, the Fed said it would increase amounts in its March 10 and March 24 term auctions to $50 billion each, a rise of $20 billion at each auction.

PERSISTENT PRICE PRESSURES

The New York Fed said separately it will sell $10 billion of its Treasury bill holdings in conjunction with the liquidity measures to preserve its bank reserve and policy rate targets.