liquidity crunch

How The BoE Killed The Global Liquidity Crunch
FN Arena News - September 18 2007

By Rudi Filapek-Vandyck


Investors in equity markets should have responded more joyfully, but they haven’t thus far. Maybe the fact that the US Federal Reserve is only hours away of announcing the size of its Fed Funds cut (widely expected 25 basis points) and also the fact that only part of the financial community has genuinely grasped the importance of the Northern Rock demise might explain the rather muted response following decisive actions undertaken by British authorities to the mortgage crisis on UK soil.


However, market analysts at GaveKal have little doubt that the global liquidity squeeze that has held banks and lenders from Europe to the US to Australia and other corners of the globe captive since July is now officially over. GaveKal believes the combination of swift UK actions and a US Fed Funds cut to be announced later today will soon pull market conditions back to normal.


This should be negative news for government bonds worldwide, but a positive for equities.


In line with GaveKal’s analysis over the past weekend, UK’s fifth largest mortgage lender Northern Rock turned out the “whale” created by ongoing tight liquidity conditions on global financial markets. What the analysts hadn’t foreseen, however, was that the British authorities would be quick in preventing this crisis from developing into a full blown banking crisis for the country.


GaveKal is now of the view that British authorities have effectively killed the global liquidity crunch - but only after announcing some truly unprecedented actions.


On the basis of information available, it would seem the Bank of England informed its government yesterday morning that nothing short of a cast-iron, legally-binding guarantee of all deposits would be required to stop the run on Northern Rock.


It only took the British Chancellor, Alistair Darling (and the rest of the British government, we assume) a few hours to act in accordance with the BoE’s advice.


The result is, says GaveKal, Britain has now responded more boldly and decisively to this crisis than anyone imagined possible 24 hours ago.


The British Treasury has now guaranteed 100% of the deposits of Northern Rock without any upper limit. In addition, the same guarantees have been extended to any other banks that might qualify for the Bank of England’s help as the lender of last resort.


As GaveKal points out, this blank-check guarantee for the entire UK banking system is unprecedented in British history and it may well be unprecedented in the history of any other advanced economy.


Expect LIBOR rates to come down and capital to become less scarce from here onwards, the analysts say. This is the beginning of the end of the global liquidity crisis, and it would appear the British have stolen the thunder from under the nose of the US Federal Reserve.