Crisis could push interest rates down
Paul Vieira
Sun
Central banks in Europe and North America intervened Thursday to inject tens of billions of dollars into financial markets to alleviate a cash crunch — a move analysts suggest may affect pending decisions on interest rates.
The central banks’ initiative was meant to reassure traders over credit concerns resulting from a meltdown in the U.S. sub-prime mortgage market.
But traders were anything but reassured.
The blue-chip stock index in Toronto plummeted 280.18 points to its lowest level in more than three months, and the Dow Jones Industrial Average in New York fell a stunning 387.18 points, or 2.8 per cent; the Canadian dollar lost nearly a cent in value, closing at 94.65 cents US; gold futures for December delivery shed more than $13 US an ounce; and base metal prices, led by nickel and copper, tumbled amid concern of tightening demand.
The cash injection was spurred by news that BNP Paribas, France‘s largest bank, had to shut down three investment funds because of their exposure to U.S. subprime mortgages. This, in turn, drove up borrowing rates on the overnight lending market, where financial institutions buy and sell funds to meet reserve requirements, to levels well above the central banks’ target rates indicating there were insufficient funds to meet lenders’ demands.
The European Central Bank intervened, adding almost 95 billion euros ($138 billion Cdn.) to the system in an effort to dampen upward pressure on overnight rates. The U.S. Federal Reserve followed, with a $24-billion US injection. The Bank of Canada, through the buyback of government of Canada securities, added an extra $1.64 billion.
A spokesman for the Ottawa-based bank said the buyback was part of normal operations, but acknowledged the amount of cash injected represented a big increase from previous days’ activities. In contrast, the Bank of Canada injected $663 million into the market on Aug. 2 and $410 million on Aug. 7.
Some analysts said this suggests the subprime meltdown could put pressure on David Dodge, the central bank’s governor, when he decides on interest rates. It was widely expected that the bank would raise its benchmark rate by another 25 basis points on Sept. 5 to keep inflation in check, but some are now thinking the rate may stay put at 4.5 per cent, or even be lowered.
“If conditions sour enough, and the spillover of the U.S. subprime situation to the overall economy is more significant than thought, then the Bank of Canada might be willing to act on the interest rate front,” said Marc Levesque, chief economics strategist at Toronto-Dominion Bank.
Ted Carmichael, chief Canadian economist at JP Morgan Chase Canada, said the sub-prime fallout has thrown a “wild card” into the Bank of Canada’s decision-making process.
“This is very much an hour-to-hour, day-to-day, week-to-week situation,” the economist said. “It is something that if it proves temporary, the Bank of Canada’s decision won’t be affected. However, if it something is a lasting problem — where we will have problems with the overnight market on a daily basis — it could clearly affect the bank.”
Bank freezes funds
PARIS — France’s biggest-listed bank, BNP Paribas, froze 1.6 billion euros ($2.3 billion Cdn) worth of funds on Thursday, citing the U.S. sub-prime mortgage sector woes that have rattled financial markets worldwide. The frozen funds amount to less than 0.5 per cent of funds under management for the euro-zone’s second biggest bank by value, but later in the day, a separate European fund valued at 750 million euros was frozen too, and a Dutch bank pulled its planned new listing after suffering sub-prime losses.
