Central banks’ action lifts markets

Co-ordinated action by six central banks sent stockmarkets into a sharp relief rally last week on signs that the international community were willing to intervene in the eurozone crisis.

America’s Federal Reserve along with the Bank of Canada, the Bank of England, the Bank of Japan, the European Central Bank and the Swiss National Bank announced they would act in concert to provide ­liquidity support to the global financial system. In essence, this means providing cheaper dollar funding to banks in Europe and elsewhere struggling to finance themselves.

Such extraordinary action underlined the growing impression that sovereign debt problems in the peripheral eurozone had developed into a broader credit squeeze in recent weeks. Concerns surrounding banks’ exposure to distressed sovereign debt have raised questions over the strength of their balance sheets. (article continues below)

While the decision to act was welcomed, the fact that it was considered necessary highlights the spread of the debt crisis into the broader economy. As the Fed said in its statement on the measures:

“The purpose of these actions is to ease strains in financial markets and thereby mitigate the effects of such strains on the supply of credit to households and businesses and so help foster economic activity.”

Keeping the banking system afloat, however, is only buying European politicians a little more time to find a solution to the underlying structural problems of the monetary union. Angela Merkel, the German chancellor, conceded the need for fundamental treaty changes last week but reiterated that a Eurobond with joint liability was “not acceptable”.

Both Merkel and Nicolas Sarkozy, the French president, expressed their commitment to the euro project, but without firm plans it is uncertain how sustainable the resulting market rally will prove.

Taylor Graff, a member of the fixed income investment team at Brown Advisory, says:

“[The central banks’ intervention] does nothing to address the core problem that the eurozone is facing – the toxic combination of excessive government debt burdens, increasing cost of financing and anaemic economic growth.

“Therefore, in the long run, the central banks’ move will only be fruitful if it heralds more decisive intervention from European policymakers.”