Fed saves Europe's banks as ECB stands pat
Stripped to essentials, America is once again having to rescue Europe from itself.
By Ambrose Evans-Pritchard,
International business editor
9:01PM GMT 30 Nov 201
The interwoven banking and sovereign debt crisis in the eurozone has become so dangerous for the world that the US Federal Reserve has been forced to take emergency action, acting as global lender of last resort to shore up Europe's banking system.
That it should have to do so as Germany and the European Central Bank hold back for legal reasons and refuse to commit decisive power adds a strange diplomatic twist.
The move came once it was clear that Europe's prostrate banks would struggle to roll over $2 trillion (£1.3 trillion) of debts denominated in dollars. Data from ratings agency Fitch shows that US money markets have slashed funding for French banks by 69pc and German banks by 50pc.
Strains have been ratcheting up over the past two weeks. European banks are mostly shut out of the dollar market, or only able to raise money for a week at a time.
The so-called "stress alarm" – the euro/dollar three-month cross currency basis swap – spiralled down to minus 166 points early on Wednesday, uncannily like the last days before the Lehman crisis metastasized in October 2008.
The stress has been rising in lockstep with Italian, Spanish, Belgian and French bond yields for two weeks, but became violent after eurozone finance ministers admitted on Tuesday night that they were unable to leverage Europe's bail-out fund much beyond €600bn (£514bn). "Conditions have changed, so it is likely to be less than €1 trillion," said Eurogroup chair Jean-Claude Juncker.
The joint offer of currency swap lines by the central banks of the US, Britain, Japan, Canada, Switzerland and the ECB preserves the polite fiction that this was to "ease strains in financial markets and thereby mitigate the effects of such strains on the supply of credit", but this was a Fed action to provide cheap dollar funding and head off a lethal crunch in Europe.
China took its own precautions – perhaps in concert – cutting its reserve ratio for the first time in three years to boost liquidity.
"Concerns have been building that Europe's banking system could go into meltdown," said Marc Ostwald from Monument Securities. "But the central banks may also have been worried that eurozone politicians will fail to deliver much at their December summit, so they need a mechanism in place to cope with the fall-out.”
Andrew Roberts, rates chief at RBS, said European bank stress was reaching extreme levels. "They couldn't allow a sudden stop to the system. This at least takes away the precipice risk for now, but Europe is not going to able to tackle this crisis properly until Germany agrees to cross the Rubicon and accept massive bond buying by the ECB," he said.
There is little evidence yet that Berlin is willing to lift its veto on eurobonds or an ECB blitz. Chancellor Angela Merkel said it was "not appropriate" for to Germany drop its objections as a quid pro quo for backing from other EU states for treaty changes to police budgets. German finance minister Wolfgang Schauble said mass bond purchases and eurobonds are both illegal under EU treaties and remain "out of the question”.
However, Germany is increasingly isolated, both in EU capitals and on the ECB's governing council. Austrian, Dutch and Finnish ministers have all opened the door over recent days for a bigger role for the ECB.
The Bank of France's governor Christian Noyer appeared to break ranks on Wednesday with the German-led bloc of ECB hawks, reflecting the political rift between Paris and Berlin on crisis strategy.
"It is essential to stabilise European bond markets. We have to recognise that the necessary degree of fiscal adjustment is heavily dependent on the level of market confidence," he said.
Jacques Cailloux from RBS said the ECB will cut interest rates to 1pc – perhaps 0.75pc – next week. It will take action to back-stop the financial system but will not yet open the floodgates to bond purchases or resort to quantitative easing.
"While the ECB is not the lender of last resort for sovereigns, it is for banks," he said. The measures are likely to include extending unlimited credit to lenders under its Long-Term Refinancing Operation (LTRO) to two or three years, with a broader range of collateral accepted, such as certificates of deposit and even dollar assets.
Whether such steps can bring Euroland back from the brink is unclear. Eurozone ministers appear to have little up their sleeves, hoping that the International Monetary Fund can do part of the heavy lifting. "We envisage a greater role for the IMF: that will be sufficient together with the EFSF," said Jan Kees de Jager, Holland's finance minister.
Yet the IMF is short of money. A US Treasury official said Washington is not willing to pay more into the IMF at this point, while Jim Flaherty, Canada's finance minister, said the Fund should not be used to bail out rich countries.
The drama always comes back to the ECB. Will it blink?