Credit crunch could spell end of rate rise cycle
However, the extension of loans to high-risk borrowers through sub-prime lending brought the US and Europe to a credit crunch.
The European Central Bank was forced to inject €94.8 billion into money markets to prevent chaos.
The pressure mounted when investors took fright after BNP Paribas stunned European markets by freezing three funds exposed to the subprime mortgage market in America.
Paribas blamed a complete lack of credit availability in certain segments of the US market.
The problem is that lenders are fearful of underestimating the risks involved in lending to the property sector as concerns that exposure to the US sub-prime sector have developed a global reach.
As a result, lenders are losing their nerve.This is turning into a vicious circle, a fact demonstrated by Thursday’s credit crunch.
Thursday’s events were the clearest signal yet that lenders have become hyper conscious of the potential risks to which they may be exposing their banks.
Hence the dearth of credit that forced the ECB and the US Federal Reserve to make billions available to the banks to ensure the global economy kept functioning.
Investors were also forced to sell stocks to increase their liquidity.
That resulted in another torrid day on the markets that left the ISEQ down €3bn at one point.
Further carnage was in evidence yesterday with the ISEQ down about €4bn as the property lending issue dealt a further blow to stock markets globally.
Ian Richards of the European arm of ABN Amro said the credit crunch reflected the reality that high-risk lending in the US has a broader reach than previously supposed.
“As the financial sector across Europe shows its hand over the next weeks and months we will see where the exposure exists,” he said.
The release of more than €95bn by the ECB into the markets on Thursday was the noble action of a lender of last resort.
Banks were unable to raise credit in the markets and unless the ECB intervened billions worth of deals could not have been done.
According to European analysts, Thursday was the closest thing to a credit crunch that you can have, which is scary when trying to keep the engines of an economy functioning.
It was significant too that on Thursday the ECB pledged it would fully honour all demands for credit from financial institutions on the day.
That was reassurance on a grand scale and it forced the Financial Times to ask yesterday if the ECB knew something the rest of us didn’t.
The rates at which banks can borrow on the wholesale markets have been showing signs of interest rate pressure.
In the US, overnight money went 0.5% higher than the norm on Thursday, forcing the Fed to pump billions into an increasingly jittery financial sector.
But this turn of events may not all be bad news. This cloud could have a silver lining — it may mean the end of the interest rate tightening cycle.
Raising interest is the mechanism deployed by central bankers to slow credit growth and to ensure price stability.
NCB economist Eunan King suggests the events of the past few days may be a clear signal that the interest rate cycle has run its course.
If credit has tightened of its own volition that could make another rate hike by the ECB unnecessary.
This crisis may have arrived just in time to prevent the Irish housing market from becoming a basket case as some analysts fear.
That would be good news indeed.
