Global central banks ease credit strain

Financial firms will be allowed to use securities backed by home mortgages as collateral for central bank loans.

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Stocks surged, bonds fell and the long-suffering US dollar soared in reaction to the moves, a sign financial markets saw the plan as a step in the right direction to ease a crisis that has threatened world economic growth.

The Dow Jones industrials closed nearly 3.6 per cent higher.

In the latest effort to ease a credit contraction that has disrupted global finance, the Fed, Bank of Canada, Bank of England, European Central Bank and Swiss National Bank announced a series of aggressive measures to boost liquidity.

It was the second time in three months that central banks from around the globe had launched coordinated efforts.

Wall Street economists were quick to call the new lending facility a step in the right direction, but what's most needed is time for the deleveraging of billions of dollars in loans globally.

“What we've seen is really a seizing of the money markets and it will help to alleviate this by injecting much needed cash,” said Kathleen Stephansen, director of global economics at Credit Suisse in New York.

“It doesn't take away the credit crunch because deleveraging will still have to take place. But this will make it a more orderly process.”

Policymakers are particularly concerned that tightening credit conditions, sparked by the US sub-prime housing meltdown, will curb the flow of money to the people and businesses that power the global economy.

The Fed expanded its securities lending program, offering up to $US200 billion ($A216 billion) of highly liquid US Treasuries to primary dealers, secured for 28 days, and said it could increase the size of the program if needed.

It also significantly expanded the types of securities that can be used as collateral for the loans.

In effect, the plan allows banks to exchange unwanted mortgage notes for easy-to-sell government securities.

“Is this going to cure what ails the economy? I would guess everyone realises the answer to that is going to be 'no'. Is this going to be helpful in addressing the strains in financial markets? For sure, the answer is 'yes',” the first deputy managing director of the International Monetary Fund, John Lipsky, told Reuters.

The yield spreads on interest rate swaps over US Treasuries, which investors use to hedge or to speculate on rate moves, made their biggest single-day move since the day after the September 11 attacks.

The Fed's moves came after some huge holders of mortgage-linked debt received demands for more cash as the value of the securities they held plunged.

Investors, paralysed by fears of a market shutdown, have shunned large sectors of the debt market, causing prices to tumble and leaving many offers for sales unfilled.

The action came on the heels of an announcement from the Fed on Friday that it would expand auctions of short-term cash to $US100 billion ($A108 billion) in March and launch a series of repurchase agreements expected to be worth $US100 billion ($A108 billion), bringing the total of recently announced steps to a hefty $US400 billion ($A432 billion).

In addition to its efforts to increase financial market liquidity, the US central bank has shaved 2.25 percentage points from benchmark interest rates since mid-September in an effort to offset the impact of the credit tightening.

Economists widely expect at least another half-point reduction when the Fed's policy-setting committee meets next week.

Goldman Sachs economist Jan Hatzius said the latest steps make a more aggressive cut less likely.