Markets show signs of stability

Investors were handed some long-awaited relief in the credit world yesterday with signs that conditions could be stabilising in parts of the money markets.

Data from the US Federal Reserve suggested that investors are now starting to buy commercial paper - short-term corporate and financial debt - again, after they deserted this sector in August due to a widespread panic about losses on subprime securities. The amount of outstanding asset-backed commercial paper was broadly unchanged last week, having shrunk by 20 per cent in August.

The news prompted further rallies in equity markets. The S&P 500 was 1 per cent up in early afternoon US trading, while the FTSE 100 closed 0.91 per cent up at 6363.9 in the UK. The Irish market was flat, with construction industry concerns weighing on stocks.

Meanwhile, the cost of borrowing money for three months in the interbank market fell slightly for sterling, dollar and euro instruments after rising to unusually high levels recently.

These signs of stabilisation will offer some reprieve for central bankers, who have pumped liquidity into the markets at a near-unprecedented rate in recent weeks to stave off a crisis.

The Bank of England yesterday provided an additional £4.4 billion (€6.44 billion) worth of funds to UK banks, but the move was far more timid than steps by the European Central Bank (ECB). There were signs yesterday that a policy rift between these two institutions could now be widening, with some ECB officials blaming the Bank of England's timidity for the scale of the current interbank problems.

Such criticism could grow in the coming days, if sentiment in the money markets remains fragile. The cost of borrowing three-month money remains extremely high by historical standards, running 113 basis point above the base rate. This reflects concerns that banks may be forced to extend liquidity lines to some investment vehicles in the coming days if these cannot raise sufficient finance in the commercial paper market.

However, some bankers also fear credit markets will soon face new pressure as troubled hedge funds start large-scale fire sales of their assets. These is also concern about the difficulty that banks are facing in clearing their backlogs of unsold loans to risky some investors, such as private equity groups.