Bank of England in dramatic turn on 3-month money

By Philip Aldrick
The Telegraph, London
Wednesday, September 19, 2007

http://www.telegraph.co.uk/money/main.jhtml;jsessionid=KS0IE3USQZ1D1QFIQ...

The Bank of England has made an embarrassing U-turn by flooding the capital markets with L10 billion of emergency three-month money and widening the asset classes it will accept as collateral against the loans.

Financiers have been calling for the Bank to relieve pressure in the three month inter-bank lending market for weeks but, earlier this month, Governor Mervyn King expressly stated that the three month market was not the Bank's concern.

Its position changed this morning, when it said: "This measure is being taken to alleviate the strains in longer-maturity money markets." The Bank will accept "mortgage collateral" in the auction and charge interest at 6.75 percent.

Bankers claim that, had the three-month money been available, Northern Rock may not have resorted to the emergency facility that panicked customers, irreparably tarnished its reputation, and has caused the share price to halve.

Matthew Sharratt, an economist at Bank of America, told Bloomberg: "One can only say that it does represent something of a U-turn. It's likely that the pressure on Northern Rock would have been considerably less had this policy been undertaken a couple of weeks ago."

Bankers said the key development was the widening of the range of securities it accepts as collateral. The decision will allow banks to use the mortgages they have written as assets against which to draw down on the £10bn facility. Previously, only gilts would be accepted.

By widening the accepted collateral class, the Bank is finally following the US Federal Reserve and the European Central Bank. However, bankers said it may have been too little too late. The Fed decision to cut rates by half a percentage point has already relieved some pressure on the three-month inter-bank market and that prime mortgage securities can be used to raise funds at less than the bank's penal 6.75 percent rate.

One financier said: "You can fund good quality paper at less than that at the moment, but this will have the effect of capping the three month lending rate at 6.75 percent. This will only be attractive if they accept weaker assets as collateral or if they lower the rate."

He added that the City was looking for more detail on exactly what quality of "mortgage collateral" will be accepted.

* * *

GATA is grateful for financial contributions, which are federally tax-deductible in the United States.