The Federal Reserve on Monday prepared to pour an extra $630bn (€437bn, £350bn) into the global financial system in coordination with other central banks around the world, in a massive effort to curb extreme stress in international money markets.
The move is designed to reinforce the impact of the $700bn bail-out bill proceeding through the US Congress and directly relieve market stress in the near term, before the new government fund can start operating.
The huge increase in official sector lending is designed to neutralise rollover risk. The interbank money market is essentially paralysed, as no-one will lend for fear that the borrowing institution will not be able to roll over the rest of its outstanding funding.
This is putting extreme pressure on weak financial institutions – forcing the authorities to step in and rescue banks on both sides of the Atlantic – and threatens to intensify the credit squeeze in the real economy.
The coordinated move is intended to encourage banks to start lending again knowing that the borrowing bank will always be able to secure the remainder of its near-term funding needs from its central bank. The Fed said it would more than double the amount of dollars it provides to foreign central banks to distribute to banks abroad from $290bn to $620bn. The European Central Bank will now have $240bn to lend, the Bank of Japan $120bn, the Bank of England $80bn and the Swiss National Bank $60bn. Sweden's Riksbank, Australia's Reserve Bank and the Bank of Canada will have $30bn each, while Norway's Norges Bank and Denmark's Nationalbank will distribute $15bn.
The action reflects the US authorities' new crisis-fighting strategy of combining gigantic liquidity operations with large-scale fiscal intervention in troubled asset markets, while holding in reserve the possibility of further interest rate cuts.
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