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Friday, September 16, 2011

Financial crisis: spectre of credit crunch returns as banks pump money into markets

Financial crisis: spectre of credit crunch returns as banks pump money into markets

As the head of the International Monetary Fund warned of a new “dangerous phase of the crisis”, the Bank of England and other central banks said they would start lending cash to European banks that were struggling to borrow.

Such “liquidity-providing operations” were last conducted in 2008 and 2009 at the height of the credit crisis, when banks’ reluctance to lend to one another threatened to cripple the financial system.

The latest developments came on the third anniversary of the collapse of Lehman Bros, the US bank whose demise brought the financial system to the brink of meltdown.

The central banks’ fresh intervention, which will run from October until December, was driven by the deepening crisis in the eurozone, which is struggling to cope with the debts of countries including Greece.

George Osborne, the Chancellor, is to admit that Britain is “not immune” to the international crisis, telling The Daily Telegraph Festival of Business that recent events make it all the more important for the Coalition to stick to its deficit-reduction plans.

The eurozone debt crisis has led to growing fears in financial markets about the stability of major European banks, especially those in France.

Investors, particularly US money-market funds, are increasingly worried that the European banks are exposed to huge losses on loans they have made in Greece and other indebted eurozone countries.

Assurances from European regulators have not allayed those fears. Moody’s, a credit ratings agency, has downgraded two of France’s biggest banks, Société Générale and Credit Agricole, and issued a downgrade warning to a third, BNP Paribas.

The Financial Services Authority, the UK market regulator, called senior executives from British banks to a meeting to discuss the City’s ability to withstand the eurozone crisis.

Stock markets jumped after the intervention, with bank shares rising sharply, amid relief that an immediate financial collapse had been averted.

The FTSE 100 index of leading British companies closed at 5,337, up 2.1 per cent. Banking shares made the biggest gains: Lloyds Banking Group rose 6.6 per cent, Barclays gained 4.4 per cent and HSBC rose 3.8 per cent. European and American markets also rose sharply.

However, analysts warned that the short-term measure would not change the fundamental problems in the eurozone and elsewhere.

“This is about central banks buying time for politicians,” said Michael Symonds of Daiwa Capital Markets.

Marc Ostwald, a strategist at Monument Securities, said that the central banks’ decision to “flood” the inter-bank market with money demonstrated the scale of the problem the global financial system faced.

He said the intervention implied that current funding pressures and the possibility of a Greek debt default were “threatening to completely destabilise western financial markets”.

Investors’ fears are also being exacerbated by growing evidence that major economies are slowing and could slip back into recession.

Christine Lagarde, the head of the IMF, said that international leaders must do more to address fears over debt and economic growth.

“We are certainly living through a very troubled time at the moment with great economic anxiety,” she said. “The economic skies today look troubled, they look turbulent, as global activity slows and downside risks increase. We have entered into a dangerous phase of the crisis.”

She added: “Without collective, bold action, there is a real risk that the major economies slip back instead of moving forward.”

The European Commission warned that growth in the eurozone economies would “come to virtual standstill” later this year.

The commission also cut its forecasts for growth in the British economy this year, from 1.7 per cent to 1.1 per cent.

Figures this week showed that UK unemployment had climbed above

2.5 million, and the Treasury is expected to cut its growth forecasts later this year.

Martin Weale, a member of the Bank of England’s Monetary Policy Committee, warned that Britain was at growing risk of a double-dip recession. “Looking at what’s happened in the last two months or so, anyone would have to say that it [the risk of recession] is greater than it seemed in July,” he said.

Mr Osborne will insist today that the Government will not water down its programme of spending cuts.

“Here at home we are not immune to what is going on at our doorstep. America and the eurozone are our two biggest export markets. But I am confident that we can weather this storm,” he will say.

“Our plan was designed for both good times and tough times. If we abandoned it now there would be a collapse in that confidence and a surge in interest rates.”

The Treasury is working on a package of reforms to spur growth, and Nick Clegg, the Deputy Prime Minister, has said that a “gear change” in such work is required.

But privately, ministers concede that the Government’s scope for action is limited and are looking to the Bank to provide fresh stimulus for the economy with a new round of quantitative easing.

The Telegraph

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