The global credit crunch has well and truly returned with the European Central Bank revealing plans to pump an unspecified amount of cash into money markets later today to relieve credit problems.
The move, announced direct to financial markets participants in Europe late on Friday night, will be the second time since August that the ECB has supported markets by adding liquidity.
Early Saturday morning, Australian time, the ECB said it would inject an unspecified amount of extra liquidity next week, noting "re-emerging tensions" – and would continue to do so until at least the end of the year.
That was after ECB President, Jean-Claude Trichet, said the bank would continue trying to keep short-term money market interest rates in line with its main policy rate.
This new promise of intervention came as three-month European interbank rates rose for the eighth day in a row to 5.04%, more than half a point higher than the US Fed Funds rate of 4.5%.
Figures out Friday in Europe showed the eurozone area was experiencing a slowdown in service business growth to the weakest level for more than two years.
In Britain more signs are emerging of a building and construction sector, especially mortgages, hurtling towards a crunch. Activity is down, loan origination is sliding, mortgage rates are rising, lenders are tightening their standards, and building and property servicing companies are feeling the pinch.
Back in August the ECB kicked off similar decisions by the US Federal Reserve, the Reserve Bank of Australia, the Bank of Japan and later the Bank of Canada in adding hundreds of billions of dollars to money markets in their countries to relieve the sudden onset of a credit freeze.
They injected close to $US300 billion in liquidity on August 9 and 10 as market liquidity froze and banks stopped lending to each other.
That freeze eased in late September and October as global equity markets rose (especially in Australia, China, the US and Europe), and commodities, such as oil, copper, gold, and silver surged after the Fed cut interest rates in September and then late October.
But the freeze started re-appearing in the early days of this month as more and more US, European and Asian banks were forced to reveal tens of billions of dollars write-downs, provisions and losses on subprime mortgages and their associated credit derivatives called collaterallised debt obligations, and other highly leveraged investments; as well as funding vehicles called conduits and structured investment vehicles.
The Fed pumped $US41 billion into the US markets on November 1, the day after the 0.25% cut by the Fed. That was done to try and drive market rates closer to the Federal Funds rate of 4.5%.
Then two weeks later the Fed pumped a further $US47.5 billion into the money markets to try and keep liquidity plentiful.
All this time yields on US bonds and short term Treasury notes were dropping. The yield on the 10 year bond went under 4% twice late last week and ended at 4% and the yield on two year bonds fell under 3% as investors went for safety. That was higher than the 3.50% for three note T-bills.
Helping drive this was the steady fall in the value of the US dollar and the growing fear that some major problem would erupt in a leading financial group somewhere in the US or Europe.
The $US2.8 trillion covered bond market which helps refinance mortgage lending across Europe was shut until tonight, our time late last week because it had all but frozen. On Thursday the biggest bond insurer in France was rescued by two associated shareholders in a $US1.5 billion dollar deal that took markets by surprise.
Around Tuesday-Wednesday of last week the Reserve Bank of Australia started boosting liquidity into the local interbank market, culminating in it keeping over $3 billion in the exchange settlement accounts the banks keep at the RBA each night and making sure the daily cash deficit was fully covered. The RBA also bought half a billion of residential mortgage-backed securities, the highest amount so far.
From Tuesday to Friday the RBA kept more than $3 billion in the settlement accounts each night: the stepped up liquidity management conditions managed to produce a slight fall in bank bill rates on Friday to their lowest levels last week, around 7.17% for 90 day bills and 7.29% for 180 day bills.
Even in Europe there is growing concern that the credit market slump and freeze is hurting the wider economies of the continent.
The US housing crunch market has hit construction, whitegoods, retailing and other suppliers. That in turn is producing losses for banks and lenders, reduced levels of activity for suppliers and retailers (Home Depot and white goods retailers are hurting badly); and caused all lenders to boost their pricing of risk to levels the markets are finding hard to cope with.
Financial sector profits have been hit and credit is becoming harder to obtain, especially for individual borrowers and others without much of a credit history (that includes companies with highly leveraged business models).
The next stage could be a wider slowdown in investment and consumption that hurts corporate profits on a wider scale. Then we move into a rising level of job losses, higher unemployment, demand that weakens even further and rising losses on consumer credit, such as cards and car loans.
And, if you think about it, that's exactly what the Fed said could happen to the US economy in its new look forecasts for 2008 and beyond, released last week.
