OTTAWA — The Bank of Canada and five other central banks have launched a pre-emptive strike in an attempt to head off a new global credit crunch and a possible new global recession.
In a surprise move Wednesday morning, the European Central Bank, the U.S. Federal Reserve, the Bank of England and the central banks of Canada, Japan and Switzerland said they will make it cheaper for banks to access U.S. dollars.
The measure to reduce costs and access to U.S. dollars for banks — thereby boosting liquidity and loan activity — was meant as a signal to markets that policy-makers are prepared to intervene aggressively at the first sign of trouble, said analysts.
But it does not resolve the issue of sovereign debt in Europe and the solvency of European banks with billions of euros in government bonds on their books, they added.
Still, Finance Minister Jim Flaherty called the central bank co-operation a “positive” indicator.
“One of the things that we see when there’s a great deal of uncertainty is a tightening of credit and that has been a challenge particularly with respect to U.S. dollars and some of the European financial institutions. This is a step forward,” he told reporters after a speech to a business audience in New York.
Markets reacted with unrestrained enthusiasm immediately after the announcement, which came at 8 a.m. EST. Stocks surged everywhere: Germany’s DAX traded 4.7 per cent higher; France’s CAC was up 4.1 per cent; Dow futures in New York rose 2.2 per cent, while the Toronto Stock Exchange index soared over 300 points at one point, almost three per cent.
The euro jumped up one per cent and oil was immediately up $1.45 to $101.25. The Canadian dollar climbed 1.09 cents to 98.15 cents US.
Flaherty reiterated that on the broader question of sovereign debt, Europe is rich enough to help itself and should not seek help from the International Monetary Fund, often called the bank of last resort for poorer economies.
Analysts said European banks had been seeing their costs for acquiring funding in U.S. currency rise four-fold in recent months.
But David Rosenberg of Gluskin Sheff and Associates said by email the early morning intervention by central bankers was likely triggered by a specific, large French bank, which ran into difficulties obtaining funding.
Each day, banks in Canada and around the world lend billions of dollars to each other, which then is used to lend to consumers, businesses and others who need cash for purchases, investments and other uses.
There are growing fears the European debt crisis will force them to take tens of billions of dollars in losses on the bad government debt they hold. That has made it hard for them to raise money in financial markets and could worsen a looming recession in Europe.
The joint statement said the central banks will reduce the cost of temporary dollar loans to banks — called liquidity swaps — by a half percentage point starting Monday.
“This deals with one small slice of the problem,” said CIBC chief economist Avery Shenfeld.
“It does not address the heart of the crisis, which is the risk European banks will have to take further writedowns on sovereign debt and have to pull back on activities in euros. So this doesn’t address the risk to their overall solvency.”
There are no such financing difficulties in Canada, the Bank of Canada was careful to point out, adding that it was “prudent to have these arrangements in place.”
Canadian banks are lending normally to consumers and businesses, although some borrowers are finding it harder to get money. Interest rates remain near historic lows.
The move is reminiscent of co-ordinated efforts by the same central banks in the fall of 2008 to bring down interest rates and increase cash in the financial system, through among other means asset swaps with financial institutions in return for central bank funding.
The actions were only partly successful. Credit did dry up in many parts of the world — including Canada —for all but the most credit-worthy businesses and households. That triggered a global recession across most advanced countries whose legacy still troubles most economies.
TD Bank chief economist Craig Alexander said Wednesday’s response is different from 2008 in that it creates an insurance against possible difficulties, rather than being a reaction to an existing problem.
“I think they are doing this in a precautionary way,” he said. “The global financial system doesn’t need access to increased liquidity at this time, but if Europe did lose control over their fiscal crisis and it did result in a major banking crisis in Europe, it would create (a credit freeze) like in 2008.”
Alexander said he believes European banks can benefit from the liquidity now, but others, particularly banks in North America, have access to funding.
That is the positive way of looking at matters, agreed Derek Holt, Scotiabank’s vice-president of economics, but there is also a darker interpretation.
“The other totally different take is that somebody knows something they are not telling the markets. When you get China cutting reserve ratio requirements and globally co-ordinated action across other central banks, you wonder about the risk of the next shoe to drop,” he said.
The possibility that one or more European governments might default on their debts, taking some European banks with them, has already begun to tighten credit conditions and slow interbank lending, leaving European banks dependent on central banks to fund their daily operations. Other banks are wary of lending to them for fear of not getting paid back.
That is the scenario that unfolded in 2008 and central banks want to get ahead of the events, just in case, analysts said.
Interbank funding costs in Canada has remained mostly flat since July and at lower spreads that those in Europe, U.K. or the U.S.
In announcing the measures, the Bank of Canada said it was extending its US$30-billion swap facility with the U.S. Fed set to expire next August to Feb. 1, 2013.
“The Bank of Canada judges that it is not necessary for it to draw or offer operations on any of these swap facilities at this time, but that it is prudent to have these arrangements in place,” it said.
Aside from greater access to liquidity, the central banks also said they are taking steps to ensure banks can get ready money in any currency if market conditions warrant by establishing a temporary network of reciprocal swap lines.