BOE, ECB Act to Protect Economies From Higher Rates

BOE, ECB Act to Protect Economies From Higher Rates

http://www.bloomberg.com/apps/news?pid=20601087&sid=aTAj2js3j4uQ&refer=home

By Brian Swint

Sept. 5 (Bloomberg) -- The Bank of England offered extra cash to financial institutions and the European Central Bank said it is ``ready to contribute'' as policy makers sought to shield economies from an increase in borrowing costs.

While the ECB provided emergency funds last month, this is the Bank of England's first attempt to lower the cost of credit. The collapse of the U.S. subprime mortgage market has made banks reluctant to lend to each other, boosting the rate on U.K. three- month loans to the highest in almost nine years. Both central banks will announce monthly interest-rate decisions tomorrow.

``The increase in funding rates, if it persists, could have adverse effects on companies and hurt the real economy,'' said Neil Mackinnon, chief economist at London-based hedge fund ECU Group Plc and a former U.K. Treasury official. ``Central banks are doing what they think is best, but I don't see any signs of rates coming back down until confidence revives.''

The U.K. central bank said it will offer as much as 4.4 billion pounds ($8.9 billion) on Sept. 13 at the benchmark interest rate, currently at 5.75 percent, instead of its usual higher penalty rate. The ECB said that it may act tomorrow to help restore ``orderly conditions.''

Lending Rates

The U.S. Federal Reserve, which on Aug. 17 unexpectedly lowered the rate at which it makes direct loans to banks, added $8.5 billion dollars to the banking system in a normal refinancing operation today. The overnight interbank lending rate matched the central bank's 5.25 percent target.

The overnight deposit rate for the 13 countries sharing the euro dropped to 4.15 percent, the lowest in two days, after the ECB's announcement. It had earlier risen to 4.68 percent from 4.50 percent yesterday. That's above the 4.62 percent rate reached on Aug. 9, when the ECB started to pump extra cash into the money market to smooth interbank lending.

In the U.K., the rate at which banks lend pounds to each other overnight declined to 5.91 percent after the Bank of England's announcement from 6.11 percent today, according to figures compiled by the British Bankers Association. The three- month rate was unchanged at 6.8 percent, the most since December 1998. The bank's goal is to keep the overnight rate close to its benchmark lending rate, current 5.75 percent.

The U.K. central bank has ``done the minimum to make sure markets keep functioning without creating moral hazard,'' said Tom Vosa, director of economic research at National Australia Bank in London, who used to work at the Bank of England. ``They've essentially told banks that three-month rates aren't something they have to deal with. Those will return to normal when banks decide there aren't any more dead bodies out there.''

Barclays Plc

Barclays Plc, the U.K.'s third-biggest bank, has borrowed twice at the Bank of England's penalty rate in the past month. Earlier today, Lehman Brothers Holdings Inc. recommended investors reduce holdings in Northern Rock Plc and Bradford & Bingley Plc partly because of rising wholesale funding costs, which may hurt earnings for banks. Barclays declined to comment.

``Longer term rates are likely to remain elevated until wider credit worries start to diminish,'' said Jonathan Loynes, an economist at Capital Economics Ltd. ``The longer they remain at current levels, the greater the potential effect on the economy and monetary policy.''

The Bank of England said it will pay interest on excess funds kept in commercial banks' accounts with it at the end of the monthly reserve period, a break with the usual practice of not paying interest on any extra money held in reserve. That may encourage banks to borrow from it even if they don't expect to use the money.

Three-Month Rates

That should ``relieve some pressure on interest rates for overnight borrowing which have'' in the past month ``been unusually high relative to bank rate,'' the U.K. central bank said. ``These measures are not intended, not can be expected, to narrow the spreads between anticipated policy rates and the rates at which commercial banks can borrow from each other at longer maturities (for example, the three-month interbank rate.)''

Three-month spreads have risen ``significantly'' because of a shortage of liquidity in markets for asset-backed securities, which has also affected money markets, the bank said in a statement. ``The source of these problems does not, therefore, lie in a lack of central bank liquidity.''

Bank of England policy makers will keep the benchmark interest rate unchanged tomorrow, all 60 economists in a Bloomberg News survey predict. Policy makers have raised the rate five times in quarter point steps in the past year.