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Central banks in the world's leading economies pumped extra money into the financial system for a third straight trading day this morning (NZ time), but in far smaller amounts as investor nerves steadied over the dangers of a credit squeeze.
The European Central Bank lent out an extra 47.67 billion euros ($88.88 billion) in overnight funds, its smallest amount since lending rates shot up last Thursday on fears European banks faced huge exposure to risky US mortgage debt.
Meanwhile the US Federal Reserve also injected US$2 billion ($2.7 billion) in extra cash earlier today (NZT). That was well below the US$38 billion injected to stabilize money markets on Friday, the largest amount for any single day since September 19, 2001.
The ECB said markets were beginning to return to normal, while the Fed reiterated it was ready to provide cash to the financial system as needed. That sent a soothing signal to stock markets, including Wall Street, which recovered from steep falls last week.
The stock market was also reassured by news that investment bank Goldman Sachs Group Inc and outside investors will spend US$3 billion to prop up a hedge fund that had been hammered by the recent market turmoil.
Analysts said a global credit crunch seemed to have been averted for now. But until the full extent of losses related to the US subprime mortgage market had been revealed, the market will remain on the defensive.
"This particular eruption appears to be fading, but it is the symptom that is fading and the underlying problem, which is that we don't know the exact location of subprime losses, remains," said Lou Crandall, chief economist at Wrightson ICAP.
"The system's vulnerabity to these sorts of liquidity issues is still present."
Overnight interest rates soared last week after BNP Paribas, France's largest listed bank, said it had suspended three of its funds, citing a "complete evaporation of liquidity" in pockets of the US securitisation market.
The announcement was the latest sign that the impact of a growing crisis in the US subprime mortgage market, sparked months ago by a steep rise in foreclosures, was rippling beyond US shores.
European banks, which have become highly reliant on the US interbank market in recent years to finance their dollar funding needs, were at the center of last week's credit crunch, helping drive credit spreads wider as they scrambled for funds.
At the same time, issuers of short-term debt like commercial paper have become worried about their ability to roll over their massive supply of loans. That has sent them rushing to tap backup credit lines at banks, sending short-term rates higher.
The US federal funds rate was trading at 5.12 per cent on Monday afternoon, below the 5.25 per cent target for overnight money set by the Federal Reserve. The rate spiked as high as 6 per cent last week, before tumbling below 1 per cent on Friday after the massive infusion of temporary liquidity by the central bank.
European money markets were flush with cash in afternoon trade on Monday. Bids for overnight money were as low as 3.90 per cent, compared with 4.6 per cent during Thursday's squeeze and below the ECB's benchmark rate of 4 per cent.
The ECB action followed a US$5.1 billion injection in one-week funds by the Bank of Japan and promises by other Asian central banks to follow suit if needed, helping to support stocks in Asia and Europe.
The Bank of Canada also scaled back its provision of liquidity to money markets on Monday, adding $C670 million ($864.3 million), down from $C1.685 billion on Friday.
Since mid last week central bankers have added hundreds of billions of dollars of temporary cash into money markets that had almost seized up in panic over exposure to complex credit derivatives linked to defaulting US mortgages.
Much of this liquidity has already been withdrawn from the system, however, since it was made up of short-term lending to banks that must be repaid the next day.
The main worry of investors is that undisclosed losses resulting from toxic debt that could yet trigger the collapse of banks and funds. It is this concern that has prompted banks to hoard cash rather than lend it to each other in short-term trades as usual, making interbank lending more expensive.
Industry sources said central bankers in Europe held talks with bank supervisors and financial executives over the weekend to assess the dangers from risky mortgage debt to the financial system.
Deutsche Postbank, Germany's biggest retail bank, was the latest big financial institution drawn into the subprime morass when it disclosed 600 million euros in exposure to two investment vehicles run by hard-hit German bank IKB.
South Korea's finance ministry said on Monday it was ready to supply emergency funds if credit dried up. The country's banks and insurers have invested US$850 million in the US subprime mortgage loan sector, the ministry said.
- REUTERS
