Central Banks Grapple
With Rate Decisions
As Markets Tumble
By GREG IP and JOELLEN PERRY
August 10, 2007
The world's central bankers say investors should bear the pain of their past excesses, but turmoil in credit markets is testing that hard line.
Yesterday, a French bank's surprise announcement of subprime-related losses reignited investor worries and sent short-term interest rates sharply higher. In response, the European Central Bank took unusually aggressive steps, injecting cash into money markets to bring rates back down by day's end. A few hours later, the Federal Reserve did the same in the U.S., to a lesser degree.
Nonetheless, skittish investors sent the Dow Jones Industrial Average down 387.18 points, or 2.83%, to 13270.68. Stocks outside the U.S. also sold off.
Despite yesterday's central-bank reaction to signs of market distress, there are few suggestions that global central banks are prepared to cut interest rates. Indeed, South Korea's central bank raised rates yesterday, citing the inflationary risk of excess liquidity. Australia's did so on Wednesday, citing surging consumer demand and an increased inflation risk. The Bank of Japan is expected to raise rates later this month or next.
The Fed earlier this week left its interest-rate target unchanged, and reiterated its focus on inflation while acknowledging risks to economic growth had increased. Economic fundamentals remain sound. The pullback in lending is limited primarily to the riskiest borrowers -- the ones who are offered subprime mortgages. No dangerous credit crunch has yet developed, and a rate cut now could aggravate inflation pressures, said Peter Hooper, chief economist at Deutsche Bank Securities: "Life has become more difficult for the Fed."
Futures traders are now putting 60% odds of a rate cut in the U.S. at officials' scheduled Sept. 18 meeting, and a small possibility of a cut before then.
Mr. Hooper says either of two developments could prompt the Fed to cut rates: "One is some severe market dislocations, like in 1998, and the other is developments that suddenly shift the prospective path of the economy. I see risk on both of those fronts having increased of late."
Until yesterday's ECB and Fed moves, there had been few signs of concern among central bankers. Major central banks have been generally raising interest rates -- or keeping them flat -- and emphasizing concerns about inflation. Many had fretted that investors had become too cavalier about taking risks, and suggested recent developments in markets were welcome, rather than reason to rush to cut rates.
ECB President Jean-Claude Trichet on Aug. 2 described market gyrations as a "normalization of the assessment and pricing of risks." And Bank of England Gov. Mervyn King this week said, "Interest rates aren't a policy instrument to protect unwise lenders from the consequences of their unwise decisions."
Indeed, some critics say it was the low rates central banks maintained earlier this decade that propelled the surge in risky lending and, ultimately, the current turmoil.
Yesterday's developments, however, underscore the risk that markets may rapidly go from being excessively lax with lending to excessively tight. Until yesterday, lenders were primarily avoiding borrowers whose ability to repay was clearly questionable, such as subprime borrowers, said Lou Crandall, chief economist at Wrightson Associates. "That would be manageable," he said.
The new development consists of signs that market participants may be hesitating to lend to each other "because they don't know where the losses are going to be," Mr. Crandall adds. "That's where you get a multiplier effect."
If hedge funds were unable to get the short-term cash they use to fund their trades, for example, they might have to sell their holdings, thus compounding the turmoil.
In Washington, President Bush -- meeting the press for the second day in a row -- emphasized the U.S. economy's fundamental strength and expressed confidence that markets could handle the strains without any major government intervention. "Is there enough liquidity to enable markets to be able to correct?" Mr. Bush said in response to a question. "I am told there is enough liquidity in the system to enable markets to correct."
The President's Working Group on Financial Markets -- representatives of the Treasury, Fed and Securities and Exchange Commission -- has been conducting daily telephone calls, as they often do at times of market volatility.
Trouble emerged yesterday when BNP Paribas, France's biggest bank, stopping withdrawals from three investment funds, citing volatility in the U.S. asset-backed securities market. That rattled investors because just last week, the bank had said it was "not directly impacted" by the strains in U.S. markets.
That reignited concerns about credit-market troubles, increasing demand for short-term funds and creating reluctance among institutions holding excess funds to lend them out. As a result, the overnight lending rate among countries that use the euro jumped to 4.7%, far above the ECB's 4% target.
Both the ECB and the Fed manage economic growth and prices by setting a target for the rate on overnight loans between big banks, then use open-market operations to increase or decrease the supply of funds to keep the market rate near the target. It is typically a routine operation and the actual and target rates seldom diverge much.
Yesterday was an exception. The ECB issued a statement noting "tensions in the euro money market notwithstanding the normal supply of aggregate euro liquidity," then injected |
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发表于 2007-8-10 09:02:39
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