London - Central bank action on Wednesday to ease severe
funding strains for the world's private sector banks may help cushion a brewing
global credit crunch, but it only buys some wiggle room for governments trying
to resolve the euro debt crisis and keep banks lending.
The intervention by top central banks from the world's
richest countries - including the US Federal Reserve, European Central Bank
(ECB), Bank of Japan and Swiss National Bank - involved lowering the cost of
emergency dollar funding for banks and expanding currency swap lines between
countries.
Although partly aimed at easing seasonal year-end financing
conditions in an already stressful environment, the move was an important show
of unity among the central banks.
It also showed the level of international official concern
about the threat of the ongoing euro and banking crisis to global economic
activity at large, and came the same day as China's central bank eased credit
for its commercial lenders for the first time in three years.
The ECB is also widely expected to cut interest rates again.
Although the instant market reaction to the moves was
positive - equity, commodities and risky debt markets rallied while the dollar
weakened - the moves underscore the close correlation between the euro crisis and
a renewed banking crunch.
They illustrate the fear that both are combining to deliver
another double whammy to world growth.
"There was a very dark mood developing at the back end
of last week," said Mark Cliffe, chief economist at ING.
"With the dire scenarios doing the rounds the last few
days, it’s all the more important they step in with aggressive measures to
support the banking system and show they're beginning to confront the financing
problems of the sovereigns as well."
RBS economist Silvio Peruzzo said the move was "very
welcome" and "helps at the margin". Wayne Kaufman at New York
firm John Thomas Financial said it was "all terrific news for short-term
traders".
But does it change anything for investors increasingly
bamboozled by the eurozone crisis and its threat to market risk sentiment?
A bit of help
On a technical level, the intervention makes it cheaper for
non-US banks to tap local central banks for dollars that have become
increasingly scarce and expensive on open markets, due to rising mistrust of
bank balance sheet exposure to European government bonds.
"It's been clear for some time that funding in the
dollar market has been drying up," said Richard Batty, investment director
at Standard Life Investments in Edinburgh.
"Reducing funding costs and making more liquidity
available is helpful. But the solvency issue remains."
The best illustration of current stress is the euro/dollar
cross currency swap rate, which has soared since August to levels not seen
since Lehman Brothers went bust in 2008. It fell back slightly after the
central bank action on Wednesday.
The problem for European banks and some others is that just
as their previously "riskless" government assets are being questioned
they are also are being forced to build capital ratios quickly, in Europe's
case to a minimum 9% by the middle of next year.
But the balance sheet uncertainty makes raising new debt and
equity finance for many banks almost impossible, or at least prohibitively
expensive. The upshot is a reduction of lending and a selling of bonds and
loans that is transmitting the squeeze to governments, businesses and
households everywhere.
Some analysts estimate European banks could reduce lending
by up to €3 trillion by the end of next year.
The upshot could see Western economies slip back into a
another recession next year and drag the developing world with them.
So market reaction to Wednesday's move was based on relief
that someone was trying to do something about it.
"This is providing the banks with liquidity, playing
the lender of the last resort for banks," said Jan Poser, chief economist
at wealth manager Sarasin.
"It's not the cure. Equities are driven because people
think after this action there won't be immediate bank failure and recession may
be shallow."