Currency swap expected from Fed and ECB

Central Banks Seek to Unblock Markets

From the Financial Times, London
Sunday, August 12, 2007

http://www.ft.com/cms/s/f5124170-4910-11dc-b326-0000779fd2ac.html

Central banks are expected to continue intervening in the money markets on Monday in an effort to unblock the financial system after last week's turmoil.

Investors braced themselves for further turbulence and speculation is mounting that the European Central Bank will seek to arrange a currency swap with the US Federal Reserve that would allow it to lend dollars to European banks struggling to meet short-term dollar funding needs.

Billions in dollar-denominated borrowing by European banks comes due in the next few days amid fears that US banks are unwilling to extend short-term credit to some of their European counterparts perceived to be vulnerable to the market turmoil.

One banker said: "The attitude is 'don't show me anything east of a [New York] 212 area code.' If you lendto [those banks], it could be a career-ending experience."

Central bankers made it clear last week that they would step in to ensure that funds were available to hold short-term interest rates close to their target levels.

In spite of market speculation that interest rates will soon be cut, the central banks have given no indication that they will need to take such drastic action and see the current crunch partly as a welcome repricing of risk.

The Fed is likely to be sympathetic to an ECB request for a currency swap since it would be seen as a helpful way of dealing with pressure on the overnight federal funds rate caused by European banks' thirst for dollars. It would be the first such arrangement between the world's two biggest central banks since 2001.

Chris Furness, of 4Cast, the economic consultancy, said a swap would be "a market calming measure and would be logical in the current situation."

Conditions in the money markets are likely to remain extremely difficult in the coming days as there will be no let-up in the uncertainty over the scale and location of losses in derivatives markets, initially triggered by high default rates in US sub-prime mortgages.

Investors fear that some hedge funds and other institutions will soon have no option but to start a fire sale of their assets to cover losses on their portfolios. Any rapid liquidation of trading positions would exacerbate the volatility in financial markets.

US markets ended in positive territory on Friday, in spite of huge falls in European equities, after the Fed's interventions to pump in $38bn appeared to calm nerves.

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