Banks withdraw extra funds as panic passes

Aug 15 2007 by Tony McDonough, Liverpool Daily Post

CENTRAL banks across the world have withdrawn most of the extra cash pumped into markets since last week’s credit squeeze panic as the global financial system attempted to return to some form of normality.

European shares initially fell 0.6% yesterday, but this followed the biggest one-day rally in 15 months on Monday. The fall was in line with moves in the US and Asia, where stocks slipped but bonds edged up as risk appetite remained weak.

Asia's central banks were back to business as usual and although investors remained cautious, there was little sign of the frantic selling of late last week.

The European Central Bank (ECB) added extra funds to markets for a fourth day yesterday but on a smaller scale, as central banks slowly pull out extra cash pumped in to avert panic about a credit squeeze.

The ECB withdrew a net 40bn euros (£27bn), lending out 7.7 billion euros (£4.5bn) for one day. It was the fourth such special operation since last Thursday, but each has been smaller than the previous one as market jitters have eased.

The money tides banks over until the start of the ECB’s regular weekly tender on Wednesday, which will provide 310bn euros (£200bn), a 74bn euro (£50bn) premium to estimated liquidity needs.

The US Federal Reserve topped up markets with just $2bn in extra cash on Monday, less than banks requested and way below the $38bn injected on Friday, the largest amount for any single day since September 19, 2001.

The Bank of Canada has also progressively cut the size of its liquidity injections and in Australia, the central bank's money market operations were back to something like normal on Tuesday.

The Reserve Bank of Australia (RBA) added A$2.6bn (£1.1bn) in its regular operation, which was a little higher than average but modest compared to Friday's A$4.9bn injection.

“The central banks acted quickly to keep the banking system ticking over and that's helped avoid a dramatic liquidity squeeze,” said Peter Jolly, head of research at nabCapital. “But people are clearly still nervous.”

“It’s miles better than Thursday or Friday,” a money market trader at one euro zone bank said.

Another trader echoed this view, saying: “The market liquidity situation at the moment, in euros as well as dollars, seems as good as normal.”

Central banks have now withdrawn most of the extra cash pumped into markets to calm panic over exposure to complex credit derivatives linked to defaulting US mortgages, since it was made up of short-term lending to banks that must be repaid the next day.

Still, news that more financial institutions have been hit by the mortgage problems kept the mood tense.

Investment bank Goldman Sachs said it would spend $3bn (£1.5bn) to prop up a hedge fund that had been hammered by the recent market turmoil.

Australian mortgage lender RAMS Home Loans Group said it could suffer if the volatility in debt markets continued.

John O'Brien, office senior partner at accountants KPMG in Liverpool, believes the global economy is still robust buts adds damage is still a possibility.

He added: “Growth will inevitably slow somewhat as credit is more difficult to come by and lenders and investors nurse their losses – and there is bound to be a hit to confidence.

“But for the moment, the global economy is strong and as long as a full-blown credit crunch – in which no-one is prepared to lend to anyone – is avoided, longer-term damage may not be too severe.

“On a local level, there appears to be a feeling that the impact has not yet fully cascaded down to the North West, in part due to the fact that it has happened at a time when a number of the lending banks key players are away on holiday. However, we believe it will start to hit in September, leaving some deals hanging over the summer.”

tonymcdonough