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ECB extends lending period to help ease crunch
By Carter Dougherty

Friday, November 30, 2007
FRANKFURT: The European Central Bank said Friday that it would extend a lending deadline in December to help the euro-area banking system get through a period of unusually tight credit at the end of the year.

The action marks a renewed effort by the ECB to calm a lending system that had showed signs of returning to normal recently, but now appears nearly as nervous as during the summer days when the crisis began.

"Despite the promises of central banks to maintain liquidity, the credit markets are tense," said Christoph Rieger, a fixed-income strategist at Dresdner Kleinwort in Frankfurt. "That is the odd thing about this situation."

The chairman of the U.S. Federal Reserve, Ben Bernanke, acknowledged that the crisis had not yet passed and hinted at a new U.S. rate cut at the Fed's next meeting, Dec. 10.

Speaking Thursday night, Bernanke declared that a "fresh wave of investor concern" had led to tougher credit conditions that posed new risks to the economy. He pledged that the Fed would remain "exceptionally alert and flexible" in setting policy.

The Fed's direction makes life tougher for the ECB, which decides next week on the outlook for its benchmark interest rate, now at 4 percent. It is expected to leave the rate steady, having already abandoned plans for a September raise in the face of financial turmoil.

The Fed has opted to cut rates twice since September to support a weakening U.S. economy - one element of its legal mandate. The ECB, by contrast, has inflation-fighting as its primary directive, as laid down in European treaties.

New data Friday confirmed that annual inflation reached 3 percent in the 13-nation area using the euro, far above the ECB's goal of close to, but below 2 percent.

That new information did little to ease the ECB's job. Credit turmoil is bound to take a bite out of European growth next year as well, but the bank is still holding out the possibility that it could increase rates to cool inflation.

"Compared to other central banks, the ECB now looks like it is way out on a limb," said Ken Wattret, chief euro zone economist at BNP Paribas in London. "That is an uncomfortable position to be in this environment."

In recent weeks, money markets in Europe and the United States have grown more tense, as banks hoard liquidity, presumably to guard against larger-than-expected write-offs owing to bad investments linked with the deteriorating U.S. mortgage market.

Although banks have announced roughly $50 billion in losses, broad-brush estimates suggest another $150 billion to $200 billion in losses could still hurt the bottom lines of banks and investors.

A week ago, the ECB restated a commitment it made in September to counter what it called the "re-emerging risk of volatility" in the overnight lending market, which is the part of the credit market that a central bank can influence directly with injections of cash. Banks also use the overnight market to lend to one another, a vital part of the financial system's most basic plumbing.

"Needless to say, the Federal Reserve is following the evolution of financial conditions carefully, with particular attention to the question of how strains in financial markets might affect the broader economy," Bernanke said in a speech to a business group in North Carolina.

His comments echoed those Wednesday by Donald Kohn, the Fed's vice chairman, who said that the economy might face bigger problems than the central bank had expected and that policy makers would have to be "nimble."

Earlier this week, the Fed and the Bank of England announced measures similar to what the ECB did Friday, all designed to forestall a run on credit in the final weeks of 2007.

The demand for credit typically rises toward the end of the year as banks lay in extra cash to meet obligations and ensure that they can hand off strong numbers to their auditors, who in turn certify them in annual accounts for shareholders.

In the United States, the Fed will make a series of liquidity injections stretching into next year, while the Bank of England will loan emergency funds with longer than usual repayment terms.

Still, the central banks have had little success relaxing credit markets beyond the overnight lending market.

The London Interbank Offered Rate, a benchmark price of credit that is incorporated into many different types of lending and contracts, now remains stubbornly elevated. In recent days, one and two-month lending costs have averaged between 4.7 and 4.8 percent, unusually far above the ECB benchmark rate of 4 percent.

Under the circumstances, the best the ECB can do is ensure that enough cash is available in the very short term. As announced Friday, the bank's normal midmonth lending, which typically has a maturity of a single week, will be extended in December so that loans are not due until Jan. 4.

"In this operation, the ECB will aim to satisfy the banking sector's liquidity needs for the entire two-week period, covering both the Christmas holidays and the end of the year," the ECB said in a statement.

Michael M. Grynbaum in New York and Edmund L. Andrews in Washington contributed reporting.

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