European rate increases squelched on eve of explosion in cash hunger

Credit Squeeze Puts Brakes on Rates

From the Financial Times
Friday, September 7, 2007

http://www.ft.com/cms/s/0/a79b84b2-5ca5-11dc-9cc9-0000779fd2ac.html

The scale of the credit squeeze on Thursday forced European central bankers to put a brake on interest rate rises that had seemed all but certain a month ago as they recognised the potential for the turmoil to hit households and companies.

The European Central Bank held its main interest rate unchanged at 4 percent. Jean-Claude Trichet, ECB president, said it was "appropriate to gather additional information and to examine new data before drawing further conclusions for monetary policy."

For the first time in eight years, the Bank of England issued a statement alongside its decision to keep its official rate unchanged at 5.75 percent, indicating that it had a lower expectation for inflation in the short term and a commitment to monitor closely "the evolution of both credit spreads and the quantities of credit extended."

The new mood came as fears mounted that banks and other financial institutions would struggle to refinance a surge of loans falling due next week.

Central banks also took more action in money markets to oil the wheels of the financial system. The ECB injected E42.2 billion ($57.6 billion) into euro money markets to bring down overnight interest rates and Mr Trichet announced plans for intervention next week by the ECB in the three-month money market, where rates are stubbornly high.

In the US, the Federal Reserve pumped $31.25 billion into overnight markets, its biggest intervention since August 10.

The actions brought down overnight interbank interest rates, but three-month interbank rates in the UK, eurozone, and the US stayed at the high levels reached on Wednesday.

This means banks are continuing to hoard money in case they need cash to lend to companies and financial vehicles that may have to draw on the banks' emergency credit lines if they cannot refinance their debts.

Banks and other financial institutions will attempt to refinance nearly $130 billion of European commercial paper next week, at a time when the appetite for such debt has significantly weakened.

This will be the highest weekly refinancing since the credit market problems emerged in August, according to data from Dealogic.

Many central bankers are worried that if the problems in the short-term commercial paper market continue, they will leave parts of the banking system looking fragile, particularly because financial institutions are being forced to refinance funding at an increasingly frenetic pace.

The central banks' actions come as European policymakers, central bankers, and regulators begin a series of scheduled meetings, starting with a gathering of central bank officials and others in Paris on Friday.

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Reporting by Chris Giles, Stacy-Marie Ishmael and Gillian Tett in London, Ralph Atkins in Frankfurt, and Michael Mackenzie in New York.

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