Six central banks led by the Federal Reserve lowered the cost ofemergency dollar funding for financial companies in a global effortto ease Europe's sovereign-debt crisis.

The new interest rate is the dollar overnight index swap rateplus 50 basis points, a half percentage-point cut, and the programwas extended by six months to Feb. 1, 2013, the Fed said today in astatement in Washington. The Fed coordinated the move with theEuropean Central Bank as well as the Bank of Canada, Bank ofEngland, Bank of Japan, and Swiss National Bank.

U.S. and European stocks rallied on the move aimed at easingstrains in markets and boosting central banks' capacity to supportthe global financial system. The cost for European banks to fund indollars rose to the highest levels in three years today as concernsabout a possible breakup of the euro area increased after leaderssaid they'd failed to boost the region's bailout fund as much asplanned.

“It's a step in the right direction,” said Jay Bryson, globaleconomist with Wells Fargo Securities in Charlotte, North Carolina.“It doesn't solve the problem in Europe, but to the extent thatEuropean banks are having trouble raising dollar funding, it makesit easier and less costly for these banks to borrow dollars.”

The six central banks also agreed to create temporary bilateralswap programs so funding can be provided in any of the currencies“should market conditions so warrant.” Those swap lines were alsoauthorized through Feb. 1, 2013.

The dollar swap lines were previously set to expire Aug. 1,2012. The new pricing will be applied to operations starting onDec. 5. Seven-day loans would carry an interest rate of about 0.58percent, down from 1.08 percent, based on the current one- week OISrate of 0.08 percent.

“This was in response to increased tension in global financialmarkets,” Bank of Japan Governor Masaaki Shirakawa said at a pressconference in Tokyo today. “Coordinated action will give markets asense of security.”

Stocks and the euro rallied after the announcement, whileTreasuries fell.

The Standard & Poor's 500 index jumped 3.2 percent to1,234.41 at 10:20 a.m. in New York and the Stoxx Europe 600 Indexsurged 3.3 percent. The euro rose to $1.3466 from $1.3317 lateyesterday. The yield on the 10-year Treasury note climbed to 2.09percent from 1.99 percent.

“When there's concerted action by central banks, it's definitelygood,” said Jens Sondergaard, senior European economist at NomuraInternational Plc in London. “But are liquidity injections a gamechanger when the heart of the problem is in European sovereign debtmarkets?”

European Banks

European banks gained, with Barclays Plc climbing as much as 9.4percent in London trading. Deutsche Bank rose as much as 7.3percent in Frankfurt, while BNP Paribas SA and Credit Agricole SAgained in Paris.

Today's move echoes coordinated actions from the financial panicstarting in 2007 to create and expand the currency-swap lines,whose use peaked at about $583 billion in December 2008. Thecentral banks also jointly lowered their benchmark interest ratesin October 2008.

The Fed said U.S. financial companies “currently do not facedifficulty obtaining liquidity in short-term funding markets.”

“However, were conditions to deteriorate, the Federal Reservehas a range of tools available to provide an effective liquiditybackstop for such institutions and is prepared to use these toolsas needed to support financial stability and to promote theextension of credit to U.S. households and businesses,” the centralbank said in the statement.

wo hours before the Fed announcement, China cut the amount ofcash that the nation's banks must set aside as reserves for thefirst time since 2008. The level for the biggest lenders falls to21 percent from a record 21.5 percent, based on paststatements.

While today's move by the six central banks is likely to easetensions in money markets, it falls short of some calls for the ECBto step up and act as lender of last resort for the governments ofthe 17-member euro area and buy unlimited amounts of governmentbonds. Germany, Europe's largest economy, has resisted the idea,arguing it isn't the ECB's job to do so and would only be atemporary fix.

The ECB unexpectedly cut its benchmark interest rate Nov. 3 by25 basis points to 1.25 percent as the turmoil threatened to dragthe euro area into recession. ECB policy makers next meet Dec. 8,while Fed officials gather Dec. 13.

Seven-Day Refinancing

Yesterday, the ECB allotted the most to banks in its regularseven-day refinancing operation in more than two years, lending265.5 billion euros ($357.5 billion). The ECB offers unlimitedfunding to euro-area banks against eligible collateral.

“The purpose of these actions is to ease strains in financialmarkets and thereby mitigate the effects of such strains on thesupply of credit to households and businesses and so help fostereconomic activity,” the Fed statement said.

Under the dollar liquidity-swap program, the Fed lends dollarsto the ECB and other central banks in exchange for currenciesincluding euros. The central banks lend dollars to commercial banksin their jurisdictions through an auction process.

The swap arrangements were revived in May 2010 when the debtcrisis in Europe worsened. The Fed three months earlier had closedall swap lines opened during the financial crisis triggered by thesubprime-mortgage meltdown in 2007.

European lenders asked for a total of $395 million in the ECB's84-day dollar tender conducted in coordination with the Fed on Nov.9. In the first offering on Oct. 12, the ECB lent six banks $1.35billion for three months. The next three-month loan will be offeredon Dec. 7.

The coordinated action “lowers the cost of emergency funding andincreases the scope,” Mohamed El-Erian, chief executive officer, ofPacific Investment Management Co. said in a radio interview todayon “Bloomberg Surveillance” with Ken Prewitt and Tom Keene.

Central banks “are seeing something in the functioning of thebanking system that worries them,” El-Erian said.

Bloomberg News

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