Central banks open taps to tackle market squeeze

WASHINGTON/FRANKFURT/TOKYO (Reuters) - The world’s top central banks joined forces on Thursday to throw a multibillion-dollar lifeline to global markets in a dramatic effort to free up bank-to-bank lending frozen by upheavals on Wall Street.

In an unprecedented move, the U.S. Federal Reserve made an extra $180 billion available to other major central banks to lend to their local commercial banks in a bid to get U.S. dollars circulating in overnight and short-term money markets.

The latest move brought to $247 billion the total amount of dollars the Fed was providing to other central banks.

In addition, the U.S. central bank pumped an extra $105 billion dollars into the U.S. market, a record amount that built on already large operations earlier this week.

Other central banks, including the Bank of England and the European Central Bank, also lent out extra funds in their own currencies as markets reeled in the wake of a round of takeovers and mergers among top financial firms and renewed concerns about how the U.S. economy will weather the storm.

Investment bank Lehman Brothers Holdings Inc filed for bankruptcy on Monday, roiling markets, and the Fed announced an $85 billion bailout of insurer American International Group on Tuesday, worried a failure could wreak untold havoc worldwide.

U.S. President George W. Bush sought to calm unsettled nerves on Thursday, saying authorities would take further actions if needed.

“The American people can be sure we will continue to act to strengthen and stabilize our financial markets and improve investor confidence,” Bush said.

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Well-oiled money markets, where banks lend short-term funds to each other to smooth daily swings in their balances, are crucial for the proper functioning of the financial system and the economy at large.

Central banks have responded to a jump in interbank lending rates, exacerbated by investors’ flight into safe havens of gold and government bonds, by flooding markets with cash, but so far have had only limited success.

The extra central bank funds helped calm markets, but analysts warned this would likely prove only temporary.

Wall Street stock markets, which hit a three-year low on Wednesday, rose sharply at the end of the session on reports the Treasury Department might consider proposing having the government play a larger role in helping dispose of bad mortgage-related assets.

There was a huge appetite for dollars in auctions held by both the Fed and ECB, but the appetite was lower at the BoE’s first dollar auction and at an auction held by the Swiss National Bank. However, demand for pounds at a separate BoE auction was heavy as was demand for euros from an ECB tender.

Barry Moran, senior money market trader at the Bank of Ireland, said the difference in demand at the dollar auctions was partly explained by the ECB accepting a broader range of assets as collateral than the BoE.

“The markets are still very, very jittery,” he said. “I think the coordinated attempts -- particularly on the dollar sides -- has helped a little bit.”

In order to make the extra $180 billion in U.S. dollars available in other markets, the Fed increased existing currency swap lines with the ECB and Swiss National Bank, and established new ones with the Bank of Japan, Bank of Canada and the BoE. The lines will be in place through January.

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“These measures, together with other actions taken in the last few days by individual central banks, are designed to improve the liquidity conditions in global financial markets,” the central banks said in simultaneous statements released ahead of the opening of markets in Europe.

“The central banks continue to work together closely and will take appropriate steps to address the ongoing pressures.”

The SNB kept interest rates on hold on Thursday citing major uncertainties about the global economy and the impact of market moves, which it called “a matter for concern.”

In another sign of the intense demand for liquidity, the Fed said financial institutions borrowed a record $47.97 billion a day on average from the central bank via its various facilities in the latest week.

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News of the huge coordinated action brought some relief to markets, initially buoying bank stocks and bond yields and cutting dollar borrowing costs. Overnight U.S. dollar interbank lending rates dropped as low as 2 percent, matching the Fed’s target rate, according to Reuters data.

Overnight dollar Libor rates fixed at 3.84375 percent from 5.03125 percent on Wednesday, although three-month rates rose across the board and the premium over expected official rates continued to rise.

As year-end looms, adding to the already intense funding strains triggered by the biggest global financial crisis in decades, three-month lending rates are spiking upward.

“What we’re looking at is a complete breakdown of the interbank lending market,” said Sean Maloney, rates strategist at Nomura International. “What central banks have done has definitely eased the situation, but it’s not enough on its own to cure the problem, hence spreads are still widening.”

To help prevent the Fed from spreading itself too thin, the U.S. Treasury on Wednesday took the extraordinary step of establishing securities auctions to raise funds for the U.S. central bank.

The Treasury auctioned $40 billion on Wednesday, $60 billion on Thursday, and announced an additional $60 billion dollar auction for Friday and a $40 billion auction for next Wednesday. The auctions have met with intense demand.

In other operations, central banks in Japan, Australia and India pumped a further $28 billion into their money markets.

In addition, China relaxed monetary policy this week, South Korea sold dollars in the swap market and said it would try to halt the slide in bond prices, the Philippines intervened to support the peso and Taiwan warned it could use a state fund to prop up stocks.

Russia said it would assign 500 billion rubles ($19.59 billion) to support and stabilize its stock markets, where trade will resume on Friday. President Dmitry Medvedev said that half of the amount will come from the budget and that further measures could be taken, if necessary.

Additional reporting by Vidya Ranganathan and Kevin Yao in Singapore, David Milliken in Frankfurt, Sven Egenter in Zurich and John Parry in New York; Writing by Tomasz Janowski, Krista Hughes and Mark Felsenthal; editing by Gary Crosse