Fed Extends Swap Lines With ECB, Other Central Banks

The Federal Reserve authorized the extension through Aug. 1 of its temporary dollar liquidity swap arrangements with the European Central Bank and the central banks of Japan, Canada, Switzerland and the United Kingdom.

The arrangements had been authorized through January, the Fed said today in a statement. Fed officials voted in May to restart the emergency currency-swap tool to keep Europe’s sovereign-debt crisis from spreading to U.S. markets.

The swaps allow the U.S. central bank to provide the “full allotment” of U.S. dollars as needed to European central banks, the Fed said in a statement in May. The U.S. central bank had closed on Feb. 1 all swap lines opened during the last crisis, triggered by the subprime mortgage meltdown in 2007.

The extension of the swaps reflects the Fed’s desire to “keep all their options open” to ward off systemic risk rather than a sign of increasing threats to U.S. markets, said Ward McCarthy, chief financial economist at Jefferies & Co. in New York. Use of the liquidity swaps declined to $60 million last week from more than $9.2 billion in May, according to the Fed’s weekly reports on its balance sheet.

“An ounce of prevention is worth probably a gallon of cure when it comes to systemic risk,” McCarthy said in an interview. “We’ve come a long way since the darkest days but we’re probably not completely out of the woods in terms of the possibility of having more financial institutions under duress.”

Libor Rate Rises

The three-month London interbank offered rate was set at 0.303 percent today, up from 0.284 percent on Nov. 23. Libor, the rate banks charge to lend to each other, reached 0.539 percent in June.

“Global tensions have worsened over the past week because of Ireland’s crisis,” said Michael Schubert, an economist at Commerzbank AG in Frankfurt. “It doesn’t solve the problem but it’s helping soothe symptoms.”

Ireland received a European Union-led 85 billion euro bailout last month to combat its fiscal woes.
The ECB said U.S. dollar liquidity-providing operations will continue to have a maturity of seven days and take the form of repurchase operations against eligible collateral. They will be carried out as fixed-rate tenders with full allotment, the ECB in Frankfurt said in a separate statement.

In a swap, central banks exchange foreign currency with an agreement to reverse the transaction at a later date. The central banks will then lend the dollars at fixed rates to firms in their countries. Concern that financial institutions were holding too many assets of Europe’s most-indebted nations led dollar liquidity to tighten in London during May.

To contact the reporter on this story: Christopher Wellisz at cwellisz@bloomberg.net