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Bank swerve steadies nerve

The Bank of England has performed a dramatic U-turn by saying it will pump £10bn into the money markets in to ease the liquidity crunch and reduce three-month Libor.

It had steadfastly refused to provide extra liquidity despite earlier action taken by the US Federal Reserve and European Central Bank to pump cash into the system.

The BoE turn-round means banks will be allowed to borrow money against their mortgage collateral.

Royal London Asset Management economist Ian Kernohan says the switch on Wednesday last week could damage the bank’s credibility as he believes it should have either stood by its original decision or moved quickly to free up the money markets.

He says: “This represents a U-turn on support for money markets and so, when faced with the risk of a collapse in confidence, all talk of moral hazard has gone out the window. As every parent knows, it is all very well to talk tough but if you do not follow up, then your credibility is damaged.”

The Bank of England will auction £10bn in threemonth sterling funds this week and will hold three further auctions at weekly intervals, with the amounts to be decided later. Banks will be allowed to offer a wider range of collateral than is normally allowed for its standing facility, including their mortgage debt.

In September, three-month Libor reached 6.9 per cent and the spread between bank base rate and three month Libor hit a 20-year high at the start of the month. It fell back from 6.75 per cent on September 18 to 6.55 per cent on the BoE move.

The BoE says: “This measure is being taken in order to alleviate the strains in longer-maturity money markets.”

Council of Mortgage Lenders director general Michael Coogan says: “This welcome support should enable three-month funding costs to reduce and get back to more normal levels. This is good news for lenders and for their customers, particularly those with mortgages linked to Libor where hefty increases in payments were looming.”

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