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NOVEMBER 30, 2011, 1:40 P.M. ET
Central Bank Injections: Pain Killer, Not Cure
By RICHARD BARLEY
It's not the bazooka the market was looking for, but coordinated action by six central banks to provide cheaper access to U.S. dollar funding is a significant response to the crisis. It should help to reduce pressure for banks to sell assets, helping to head off a growing credit crunch within the euro zone that had started to take its toll on the global economy.
But while the action triggered a broad market rally, it also reflects the severity of the crisis and adds to pressure on European policy makers to take decisive action.
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The Fed, ECB and other central banks took coordinated action to support the global financial system as Europe's rolling debt crisis continues to trouble markets. Vincent Cignarella and Charles Forelle discuss details on Markets Hub.
The U.S. Federal Reserve, the European Central Bank, the Bank of Japan, Bank of England, Bank of Canada and the Swiss National Bank agreed Wednesday to cut the cost of borrowing U.S. dollars under swap lines by 0.5 percentage point. European banks have been struggling to get hold of dollars as U.S. money-market funds have cut lending and the cost of swapping euro loans for dollar loans had reached levels not seen since the collapse of Lehman Brothers.
.The easier terms—the rate for an 84-day dollar loan from the ECB has more than halved, RBS calculates—should make banks more willing to borrow dollars from central banks; if many banks use them, there will be less stigma attached. The central banks also agreed to temporary bilateral swaps to offer liquidity in each of their currencies, while insisting this was precautionary: There was no demand for such facilities yet.
The action is reassuring in that it shows policy makers are willing and able to coordinate to tackle the crisis. But it is also disturbing since it suggests central banks fear the euro-zone crisis could go global via the banking system and affect cross-border lending more widely. One particular area of vulnerability is trade finance, which is predominantly dollar-denominated. French banks, which have historically had a 25% market share, are deleveraging rapidly in response to the liquidity crunch and new capital rules, with knock-on effects for global trade. Another concern is that central banks are increasingly becoming central counterparties as markets malfunction.
Still, markets chose to accentuate the positive. Equities rallied hard, the euro climbed more than 1% against the dollar, the cost of swapping euros for dollars fell around 0.3 percentage point.
The central banks' action is helpful, but it only alleviates crisis symptoms. The euro zone's deep-seated problems remain unaddressed. The market is betting this action by central banks will be followed by more decisive European efforts to support bank funding and alleviate stress in sovereign bond markets. If so, this could be the turning point for market sentiment. If not, the central bank toolkit may need to be ransacked further, but it may be to diminishing effect.
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