ECB seeks breathing space for financial markets

As Wall Street yesterday (15 September) faced its biggest drop since the 9/11 terrorist attacks, the European Central Bank (ECB) attempted to appease tensions by injecting €30 billion into European money markets.

What is being termed as the ‘new black Monday’ occurred as US authorities decided it was time to draw the line on a series of high-level bailouts like that of mortgage giants Fannie Mae and Freddie Mac last weekend, leaving investment banking giant Lehman Brothers to announce its bankruptcy. 

While EU officials tend to favour a less-interventionist stance than in the US, believing it is not always possible to bail out firms, they were nevertheless hasty to add that measures to stabilise European markets would be taken. 

The Lehman case “is a shock, but at the same time it demonstrates a certain balance, which is that the US Treasury cannot constantly save those who are in a bad position,” said French Finance Minister Christine Lagarde on Monday, adding that the EU had “put in place the mechanisms that make it possible for the markets not to be destabilised [and] not to become gravely disorderly”. 

ECB providing liquidity

The European Central Bank notably decided to provide €30 billion in overnight loans to banks. And the demand was high. According to the ECB, a total of 51 banks bid for credit for a total sum of €90.27 billion during the rapid one-day refinancing operation. It further estimates the liquidity needs of commercial banks in the eurozone at €118 billion.

The Bank of England also said it would today release roughly €6 billion of reserves to give breathing space to UK banks that had lent money to Lehman to assess how much they may have lost. 

Rate cut on the agenda? 

An ECB statement further indicated the bank’s readiness to take additional measures if necessary, saying it “continues to closely monitor the conditions in the euro area money market” and “stands ready to contribute to orderly market conditions”. 

“We have to be extraordinarily alert,” said ECB chief Jean-Claude Trichet, speaking in Frankfurt on Monday. 

Up till now, the ECB has always maintained a clear distinction between its liquidity-boosting operations and its main interest rate policy, which aims to combat inflation – the bank’s primary mandate. 

However, according to the Financial Times, the tide could be changing. The paper quotes Jacques Cailloux, an economist at Royal Bank of Scotland, as saying: “With rising risks of feed-back effects from the financial crisis to the real economy, that separation could become increasingly untenable. While the ECB will obviously be reluctant to consider rate cuts, its past behaviour does not necessarily rule that out.” 

It also quotes UniCredit’s chief economist as saying the current credit squeeze “raises the pressure on the ECB [and] increases the chances the ECB will have to cut sooner rather than later.” 

The ECB could also find it has more room for manoeuvre for rate cuts as the crisis drove traders to sell off risky assets such as commodities, causing oil prices to tumble to a seven-month low at just $94 a barrel yesterday. Indeed, the drop in prices could ease inflationary pressures in the West. 

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EU struggles with tools to tackle Lehman-style crisis

A meeting of European finance ministers in Nice over the weekend highlighted the EU's lack of common tools to prevent or deal with a collective catastrophe like that currently occurring in US financial markets with the failure of two of the world's largest investment banks, Lehman Brothers and Merrill Lynch.