Central banks ride to rescue

Tim Wallace
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WORLD markets rallied yesterday, after the Fed said it was prepared to pump the global economy full of cheap dollars in a bid to stave off an impending credit crunch.

Banks can already borrow the greenback from central bankers if they are short of cash – but yesterday Federal Reserve chairman Ben Bernanke slashed the cost of doing so.

China, too, acted to stimulate the slowing economy, cutting the reserve requirement ratio for its commercial banks for the first time in nearly three years.

Stock markets across the world jumped on the sign that central banks will take co-ordinated, radical steps to stop bank funding from drying up, as it did prior to the 2008 financial crisis.

Before yesterday’s shock announcements, banks had to pay the overnight index swap (OIS) rate, currently 0.101 per cent for three months, plus a penalty of 100 basis points (bps). That penalty has now been halved.

The Fed has offered the so-called “swap line” to the Bank of England, the European Central Bank, the Bank of Japan and the Bank of Canada, so those regions’ banks can benefit.

The aim is to ease pressure in financial markets, and “mitigate the effects of strains on the supply of credit to households and businesses,” said the Bank of England.

Libor – the rate at which banks lend to each other – has risen steadily in recent months as banks trust each other less due to the debt crisis. This measure should help banks stay afloat and instil more confidence in markets.

Eurozone banks have used the swap line the most in recent months, but UK banks have not tapped it since 2009. Analysts warned that however useful the new measures are, far more radical action is needed to stop the crisis.

“We should expect further intervention in the near future given the seriousness of current economic woes,” said Yannick Naud from Glendevon King Asset Management, who said the six major central banks could engage in an unprecedented coordinated round of quantitative easing .

The Dow Jones had its best day in over two years yesterday, rising 4.2 per cent, and the FTSE 100 climbed 4.3 per cent – its biggest jump in eight weeks. The CAC40 rose 4.2 per cent and the DAX leapt 4.98 per cent.

China’s move takes banks’ requirement from 21.5 per cent to 21 per cent, enabling them to lend an extra RMB390bn (£38.9bn).