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Global Fears over Europe’s debt crisis lead to liquidity

1 Dec

In an attempt to support the global financial system, The US Federal Reserve has slashed the cost of dollar liquidity on Wednesday, making short-term loans from the European Central Bank around half the amount lower in interest.

Along with other central banks, the co-ordinated move is aimed to avoid further calamities in the global financial system.

The conversion from euros to dollars had reached a record high since the collapse of the Lehman Brothers, and there has been a stigma attached to borrowing from the ECB. Wednesday’s move has shifted the Fed’s swap lines by half, from 100 to 50 basis points, and it is hoped this will encourage bidders.

The central banks’ recognised that liquidity may not solve all of Europe’s problems, such as a possibility of a “credit crunch”, but will be a progressive step forward. Since the European crisis has spread to other countries such as the US, they are acting to help ease the problems to come.

Emerging markets have also showed signs of an attempt to soften Europe’s financial blow, with China saying it would provide its first deposit cut in three years, so banks will pay a reserve of 20 per cent, rather than 21.5 per cent. Their main worry is the threat to economic growth.

Erik Nielson, chief economist at UniCredit outlined how the co-ordinated move will only help the surface issue: “You will buy some insurance against a big, ugly accident, which would be a big bank failure or multiple small failures. But it doesn’t solve the main problem.”

Tony Crescenzi, a strategist at Pimco, thinks Europe needs to take charge of its problems:

“The provision of liquidity is no substitute for other actions that Europe must take to solve its woes. The world continues to wait on European actions on fiscal rules, discipline and enforcement, as well as use of the balance sheet that matters most: The European Central Bank.”

So what else is the ECB considering to curb their crisis?

Many economists think they should up their bond buying programme, setting limits on government bond yields.

Whilst the government is not showing readiness for this move at the moment, the Financial Times suggests they will soon change their mind.

An action they will be partaking in is making sure politicians are meeting expectations in order to help solve the epidemic.