Central Bank action - but NOT the big event we have been waiting for....

By Eoin Fahy, Wednesday, 30th November 2011 | 0 comments

Six central banks, including the European Central Bank and the US Fed, announced this afternoon that they are taking coordinated action to ease strains in financial markets and to help economic activity. A seventh, China's, announced at much the same time that it was easing monetary policy in a different way.  However, the 'coordinated action' is far from dramatic and certainly doesn't come close to being the radical step that so clearly is required to deal with the eurozone fiscal crisis.

The announcement itself was dramatic and unexpected, as the central banks of Switzerland, Japan, the UK and Canada joined with the Fed and the ECB in issuing a joint statement, the first paragraph of which read

The Bank of Canada, the Bank of England, the Bank of Japan, the European Central Bank, the Federal Reserve, and the Swiss National Bank are today announcing coordinated actions to enhance their capacity to provide liquidity support to the global financial system. The purpose of these actions is to ease strains in financial markets and thereby mitigate the effects of such strains on the supply of credit to households and businesses and so help foster economic activity. 

Off to a good start so, but from then on things got much less exciting.  Market participants probably hoped to read in subsequent paragraphs about, say, large-scale interest rate cuts, and/or measures to help countries such as Italy and Spain to sell their bonds, and/or a decision of  the ECB that it was time to throw caution to the wind and get on with the job of taking dramatic action to deal with the eurozone fiscal crisis.

But that was not what we got.  What we did get was an announcement of a highly technical and not very dramatic arrangement which will allow central banks in one country to lend the currency of another country (typically US Dollars) to their own banks, by means of "bilateral swaps" between the two central banks involved.  The margin at which they can borrow the foreign currency is being cut to 0.5% from 1.0%. This plan should make it moderately easier for banks to borrow on the interbank market.

However, while the plan was hardly very exciting, the market reaction was strong.  The euro rose by two cents against the US Dollar, and European equity markets rose around three percent. Almost certainly this reflects the fact that central banks have got together and recognised the serious problems in the financial markets, and not the importance of what they then actually announced by way of hard action. 

The markets are also reacting to the news from China today that the 'required reserve ratio' for banks there is being cut, a technical measure but one which is broadly similar in effect to an interest rate cut.  As Chinese authorities have been worried about inflation for some time, this move is significant as it shows that they are sufficiently relaxed about the inflationary threat to be able to begin to relax policy - which can only be good for economic growth.

So to sum up, these moves are indeed welcome and helpful, but certainly not the "bazooka" that markets have been waiting for.  Though if it is an indication that central banks are awake and alert to the dangers facing the global economy, then perhaps further actions can be anticipated in the weeks ahead?

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