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Last Updated: Thursday, 13 December 2007, 17:34 GMT
Cash rescue plan helps rates fall
Money

A surprise move by the Bank of England, the US Federal Reserve and three other central banks to inject cash into money markets has had an immediate effect.

The rate at which banks lend to each other fell to 6.514% from 6.627%.

There have been fears that if the rate, known as the London Interbank Offered Rate or Libor, remained high then this could lead to slower economic growth.

However, some analysts warned that the decline was not significant and may not point to a long-term change in rates.

"The coordinated announcement by five of the world's leading central banks of plans to inject liquidity into the money markets has, so far at least, had little impact on interbank interest rates," Capital Economics said.

"While interbank rates may fall further when the auctions for the extra liquidity actually take place, this will do little to resolve the underlying weakness of the UK economy," they continued.

Co-operation

Banks have become nervous about lending money because of heavy losses linked to problems in the US mortgage market, and have increased the Libor rate as a result.

In order to ease concerns about banking sector losses and add liquidity to money markets, five central banks said on Wednesday that they would make $110bn (54bn) available in loans.

As well as the Bank of England and the US Federal Reserve, the European Central Bank and the national banks of Canada and Switzerland are also involved.

Analysts said that the promise of extra cash was needed because the interbank rate had remained stubbornly highly despite an interest rate cut in the UK.

Worries about liquidity at year end can become self-fulfilling
Leigh Goodwin, bank analyst, Fox-Pitt Kelton

Many had expected the interbank rate to dip after the Bank of England trimmed its main borrowing cost last week by a quarter of a percentage point to 5.5%.

However, that did not happen and with banks still having to pay more when borrowing from each other, it was only a matter of time before consumers would also have to dig deeper to finance loans and mortgages, analysts said.

UK Prime Minister Gordon Brown welcomed the move by the central banks, telling the Times newspaper in an interview that it was "the co-operative effort I've wanted to see for some time".

The rate at which sterling is lent over three months was not the only one to be lowered. The three month dollar rate fell to 4.99% from 5.0575%, while the rate for euros dropped to 4.9494% from 4.9525%.

'Tight times'

Despite the central banks' best efforts, many analysts were unconvinced that the massive cash injection would help stave off an expected economic slowdown next year.

The Organisation for Economic Cooperation and Development has forecast that UK economic growth will slow to 2% in 2008 from 3.1% in 2007, largely because of a weaker housing market.

It also predicts that US growth will slow at the start of next year.

The US has already cut interest rates in an effort to boost growth, and most recently trimmed its main borrowing cost to 4.25% from 4.5% this week.

And while some analysts had expected the interbank rates to come down quickly, others have warned that it will take more time before lenders are confident enough to increase the amount of risk they are willing to take.

Financial institutions have been hoarding money to cover their potential losses, say bank analysts.

"Worries about liquidity at year end can become self-fulfilling," said Leigh Goodwin, bank analyst at Fox-Pitt Kelton.

Banks' fears are especially heightened this year because they "think it will be tight, so they are cautious and less inclined to lend", the analyst added.

US shares dropped slightly in early trade on Thursday after wholesale prices increased by 3.2% in November, the biggest rise in 34 years, fuelling wider inflation concerns.

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