Central banks act to provide euro zone dollar liquidity

 

Five of the world's top central banks acted jointly today to provide unlimited dollar loans to banks, a move aimed at easing the growing tensions in the euro zone's financial sector and shielding the global economy from the effects of the European debt crisis.

The European Central Bank said it will coordinate with the US Federal Reserve, the Bank of England, the Bank of Japan and the Swiss National Bank to offer three-month dollar loans to banks until the end of this year.

The coordinated effort aims to prevent Europe's debt crisis from derailing the global economy's rebound from recession, a topic that will dominate talks between US Treasury chief Timothy Geithner and his European counterparts at a meeting beginning tonight and running through Saturday in Poland.

European banks have seen their shares sink and some have had trouble getting loans from each other recently because of possible huge losses from their holdings of troubled European government bonds.

When a bank is rumoured to be in danger of suffering large losses, other banks will stop lending to it for fear of not getting their money back — a scenario that created the global credit crunch in 2008. Ultimately, the threat to the wider global economy is that banks will stop lending to businesses, thereby stifling growth.

Stocks, particularly banking shares, and the euro rallied on hopes the dollar loans will relieve the funding pressures.

Financial markets have been hugely volatile for weeks on fears that Europe's debt crisis will spin out of control and threaten Europe's banking sector. Moody's ratings agency this week downgraded two major French banks on those concerns.

International Monetary Fund chief Christine Lagarde said the joint move was "exactly what is needed" since the world has entered a dangerous phase of the crisis, and repeated her call for European countries to recapitalise their banks.

Bank of France governor Christian Noyer said all European banks, not just French ones, would have to adjust their business models and shrink their balance sheets because US money market funds were "withdrawing from Europe".

Markets and the euro currency were buoyed by today's news. The euro surged to a daily high of $1.3934 before retreating slightly to $1.3858. Shares in French bank BNP Paribas jumped 13.4 per cent while Societe Generale gained 5.4 per cent. Traders had singled them out in recent days as being particularly exposed to Greece's bad debts.

The European Commission this morning cut its quarterly growth forecasts for the second half to reflect a worsening outlook from the debt crisis and warned the euro-area economy may come "close to standstill at year-end."

Germany and France moved to shore up Europe’s ailing bailout of Greece yesterday, following fresh warnings of a “systemic” crisis in the bank sector. However, they announced no new measures.

In the face of rising doubt about the viability of the Greek rescue, and fears the country faces the prospect of a sovereign default, the French and German leaders last night said the rescue programme laid down in its bailout was “indispensable” to ensure the country’s economic recovery.

Following a credit rating downgrade of French banks yesterday, a committee of senior advisers told EU finance ministers the debacle threatens to create a “vicious circle” between sovereign debt, bank funding and negative growth.

Europe’s leaders are now confronted with the danger that the two-year long sovereign debt saga may trigger a new international banking crisis.

Finance minsters travelling to the meeting in Poland today have been warned by the Economic and Financial Committee, which comprises high-level finance ministry officials in member states that the crisis is worsening.

“While tensions in sovereign debt markets have intensified and bank funding risks have increased over the summer, contagion has spread across markets and countries and the crisis has become systemic,” the committee said.

The Stoxx Europe 600 Index rose 0.7 per cent this morning, though gains were capped after Swiss investment bank UBS said it made a trading loss of about $2 billion after discovering an unauthorised trade.

In a teleconference last evening, Dr Merkel and Mr Sarkozy urged Greek prime minister George Papandreou to fully execute the austerity measures needed to secure an €8 billion rescue loan.

As Greece runs out of cash, investors are gripped by increasing fear of a default and the risk of a consequent shock to the global financial system. This flows from anxiety over threats to the country that its next loan will be withheld if it fails to deliver promised reforms.

Although it would be open to euro zone leaders to release the money anyway, such a move would compromise their power and exert further pressure on the Greek authorities.

A French government spokeswoman said Paris wanted “guarantees” from Athens on its recovery and drew a contrast with Ireland’s delivery of its bailout plan.

“Let’s remember what happened in Ireland. At the beginning, Ireland’s recovery plan was said to be too tough, too difficult to implement,” she said. “Today, Ireland is out of the woods. Ireland has implemented its plan.”

Meanwhile, Michael Meister, the finance spokesman for Dr Merkel's Christian Democratic Union party in parliament, said this morning that reducing the euro area to a smaller group of northern countries would be "a fiasco" for Germany's export-dependent economy.