Five major central banks moved in concert Thursday to pump dollars into the European banking system by arranging three new funding operations, an action aimed at stemming a new liquidity crisis.
The European Central Bank said it will be joined by the U.S. Federal Reserve, the Bank of England, the Bank of Japan and the Swiss National Bank to conduct three U.S. dollar liquidity-providing operations.
The action addresses an acute shortage of dollar availability as U.S. lenders withhold funds out of concern that the European banking system is overexposed to the region's government-debt crisis.
The tenders appear aimed above all at ensuring that European banks keep access to dollar funding, after months in which private-sector investors have refused to roll over existing credits. In the new tenders, banks bidding, say, at the ECB for funds, will receive dollars. But the Fed's actual counterparty will be the ECB, not the banks that use the facility, reducing the risks of the transaction for the Fed.
The euro surged by more than 1% against the dollar and the yen following the central banks' move.
BNP Paribas and Société Générale have acknowledged that access to dollars through U.S. money-market funds has been drying up and both have said they have secured alternative sources of dollars. They have also cut back on dollar-denominated lending and sought to sell assets in a bid to bolster their capital, marking a potentially worrying development for a slowing economy in France and elsewhere.
German bunds and U.K. gilts fell sharply as risk sentiment got a lift from the market. The December bund-futures contract fell 151 ticks to 135.36, while the December gilt futures contract plunged by 145 ticks to 128.70.
"It's obvious the ECB is working hard to get ahead of the market's skittishness about funding availability and the markets are responding accordingly as earlier losses in safe-haven assets are extending with risk assets surging," said Adrian Miller, senior vice president of fixed-income strategy at Miller Tabak Roberts Securities.
The new dollar tenders, under which banks will be able to bid for unlimited funds, will have a maturity of approximately three months covering the end of the year, the ECB said. They will be conducted in addition to the bank's regular funding operations. The tender dates will be Oct. 12, Nov. 9 and Dec. 7, the ECB said.
The ECB last offered three-month dollars in May last year.
"This comes as good news," amid "increasing signs of tension in dollar funding for euro-zone banks," said Marco Valli, an economist at UniCredit in Milan.
European banks have lost access to more than $700 billion in U.S.-dollar funding—short-term IOUs and interbank loans—over the past year from U.S. money-market funds and others worried about exposure to Greece and other troubled European economies, according to J.P. Morgan Chase & Co. and CreditSights research.
That has forced the banks to curtail dollar-denominated lending and find dollars far afield, such as in the Middle East.
European banks need the U.S. currency to fund loans they have extended to U.S. companies and consumers. European banks also need dollars to repay past borrowings they made in dollars, such as loans from U.S. money-market funds.
On Wednesday, the ECB said two banks had tapped it for $575 million, only the second time in six months the ECB has doled out dollar funding. The names of banks that tap the ECB are kept confidential.
It remains to be seen at what rates the swap facility will be offered. The one-week funds have been deliberately offered at a rate well over the interbank market rate for dollars, so as to discourage its use.
The central banks' joint move could be enough to avert a funding crisis for now, said Greg Anderson, senior foreign-exchange strategist at Citigroup in New York. "If there is some other massive shock it may not prove to be enough but to proactively deal with year-end issues, it is probably enough."
But Geoffrey Yu, director of foreign-exchange strategy at UBS, argued that banks will continue to sit on liquidity as euro-zone governments continue to procrastinate over a solution to the debt crisis.
"This doesn't change anything," he said. "It helps the banks for the next couple of months but that's it."
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