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BOE to Inject $20 Billion to Ease Three-Month  Rates

The Bank of England made a surprise U-turn on Wednesday, offering to inject 10 billion pounds ($20 billion) next week into money markets in a bid to bring three-month interest rates down.

The BoE will then hold three further auctions at weekly intervals with the amounts to be decided later. Banks will be allowed to offer a wider range of collateral than normally allowed, including mortgage debt.

"This measure is being taken in order to alleviate the strains in longer-maturity money markets," the BoE said in a statement. "The rate paid will be as bid by participants, subject to a minimum rate set at the Bank's standing lending facility rate."

The pound and interest rate futures jumped at the prospect of extra liquidity but soon gave back ground as dealers digested the news the market would have to pay at least the Standard Lending Facility Rate, which means a minimum of 6.75%, a full point above the Bank's official rate.

"The terms of the offer are not that attractive," said Stephen Lewis, economist at Insinger de Beaufort. "It's questionable whether this will free up the money markets in the intended way."

There will also be a limited amount of money on offer. Interbank lending has all but dried up and the cost of three-month money has soared as banks' worry about each others' exposure to dodgy U.S. mortgage debt.

Northern Rock Added Pressure

Worried about moral hazard, Governor Mervyn King had previously said that it was not the BoE's job to bring down three-month money rates and had not joined the Federal Reserve and the European Central Bank in pumping billions into the financial system.

Sources at the BoE said there was no inconsistency. The governor had said last week that central banks should be ready to take appropriate action if the whole financial system were threatened.

"Clearly, the problems surrounding Northern Rock have added to pressure on the Bank to normalise money markets," said Philip Shaw, chief economist at Investec.

Britain's fifth-biggest mortgage lender, Northern Rock, was forced to seek an emergency funding line from the BoE last week, prompting a run on deposits from savers and raising fears of a wider banking crisis.

While that appears to have been averted for now by the government guaranteeing all deposits, market conditions have remained volatile.

"Clearly the deterioration in the financial market situation has deteriorated to the point that the slowdown implied for the economy is more severe than the Bank had seen as desirable," said Alan Clarke, economist at BNP Paribas.

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