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Asian Central Banks Drain Liquidity as Markets Calm

Asia's central banks were back to business as usual on Tuesday as the fallout from the global credit squeeze abated, at least for the moment. In a clear sign that the scramble for cash was easing, the Bank of Japan (BOJ) drained money from the country's banking system as surplus funds drove down the call rate.

With the overnight rate trading near 0.1%, well below its 0.5% target, the central bank offered to sell 600 billion yen (US$5.1 billion) in bills, so mopping up Monday's injection.

"We judged it appropriate to drain funds as market rates were trading low in early dealings, indicating that there is ample funds in the system," a BOJ official told Reuters.

In South Korea, top economic policy makers including the finance minister and central bank chief met early on Tuesday to discuss the U.S. subprime mortgage crisis and its potential consequences.

Yet they were at pains to play down the importance of the talks, denying media reports that it was an emergency meeting.

"It's a kind of regular one, and the subprime mortgage issue was among the main subjects today because that is important," said a finance ministry official, who declined to be named.

In Australia, the central bank's money market operations were back to something like normal on Tuesday, although bad news from a mortgage lender kept the mood tense.

The Reserve Bank of Australia (RBA) added A$2.6 billion (US$2.2 billion) in its regular operation, which was a little higher than average but modest compared to Friday's A$4.9 billion injection.

"The central banks acted quickly to keep the banking system ticking over and that's helped avoid a dramatic liquidity squeeze," said Peter Jolly, head of research at nabCapital. "But people are clearly still nervous, wondering where the next body is buried," he added.

That wariness showed painfully on Tuesday when Australian mortgage lender RAMS Home Loans Group said it could suffer if the volatility in global debt markets continued. The market immediately slashed 20% off its share price, even though RAMS had no direct exposure to the U.S. subprime mess.

Cash Flood Flows

The calmer tone in Asian money markets followed fresh action by the European Central Bank, which lent out 47.67 billion euros ($65.29 billion) in overnight funds on Monday.

That was the third straight session of sizable injections, but half the size of the 94.8 billion euros lavished on the market last Thursday as rates jumped on fears European banks faced huge exposure to risky U.S. mortgage debt.

The U.S. Federal Reserve had to add only a modest $2 billion in extra cash on Monday, far below the $38 billion injected to stabilize money markets on Friday.

The ECB said markets were starting to return to normal, while the Fed reiterated it was ready to provide cash to the financial system as needed. That seemed to soothe investors and Wall Street steadied after steep falls last week.

The stock market was also reassured by news that investment bank Goldman Sachs Group and outside investors would spend $3 billion to prop up a hedge fund that had been hammered by the recent market turmoil.

Still, private equity firm Kohlberg Kravis Roberts warned that weak debt market conditions could cut into its investment returns and confirmed that the U.S. Department of Justice was probing it for anti-trust violations.

"In the context of recent price action, an element of normality seems to have crept back into markets," said Darren Gibbs, chief economist at Deutsche Bank in New Zealand. "Whilst the Fed only injected $2 billion of liquidity, federal funds generally traded at or below the formal 5.25% target rate," he added, noting the VIX measure of market volatility also fell 6% on Monday.

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