Central banks in the US and Europe pumped money into the financial system yesterday to try to unglue the money markets as the price of inter-bank lending continued to rise, causing fears about the wider economy.
The US Federal Reserve injected $31.3bn (£15.5bn) into the banking system and the European Central Bank pumped €42.2bn (£28.5bn) into the money markets.
Central banks are trying to encourage banks to start lending to each other again after rocketing defaults by risky US mortgage customers caused the value of bonds backed by the loans to tumble. The market for all but the safest forms of debt has virtually dried up because financial institutions are worried about where losses from exotic securities and derivatives will turn up next.
Australia's central bank also acted to free the system by saying it would buy top-rated bonds backed by mortgages and would also purchase asset-backed commercial paper.
The actions taken by central banks yesterday contrast with the approach of the Bank of England, which took limited steps on Wednesday to encourage overnight lending but said it would not act to reignite the market for longer-term loans. The Bank has refused to bail out the financial markets from problems caused by the lucrative debt frenzy that ended suddenly last month.
Economists at Dresdner Kleinwort said the UK economy was more dependent on financial market activity than other countries in Europe, making Britain more at risk from a downturn in the financial sector.
The Bank of England said it was keeping a close eye on whether events in the credit markets were having an impact on companies or consumers. The rate for three-month Libor continued to rise, hitting a new high of 6.878 per cent, up from 6.8 per cent on Wednesday.
"The Bank has said to the banks 'This is your problem, not ours', but it could quickly become the Bank's problem if you get rationing of credit," Alan Clarke, UK economist at BNP Paribas, said.
The International Monetary Fund said it expected the turbulence in markets to hit global economic growth, particularly in the US but also in Europe.
Concern continued to surround investment funds set up or run by banks that contain US mortgage-backed debt. Structured investment vehicles (SIVs) run by Citigroup, the biggest US bank, said their credit quality was "very strong" and they had been able to sell almost $7.6bn of commercial paper to fund themselves in August.
Moody's, the ratings agency, said on Wednesday it had cut or might cut $14bn of debt issued by SIVs, which are under severe pressure as the value of their assets falls and the cost of selling short-term debt rises.
Other banks have had to fund similar investment vehicles themselves as the market for the commercial paper they issue has seized up. Australian banks made commitments to off-balance sheet conduit funds, with National Australia Bank taking A$6bn (£2.45bn) of loans back on to its books from one of the funds.
HBOS took on responsibility for its $35bn Grampian conduit fund last month, though other UK banks have said they are still funding their conduits in the commercial paper markets. Potential commitments to conduits are adding to banks' reluctance to lend to each other, adding to fears lack of credit will hit the economy.
In the US, the commercial paper market suffered, with the market for the short-term debt that many companies rely on shrinking by more than 13 per cent in a month. Federal Reserve data said the market had shrunk heavily for four weeks running.
The US housing market slump caused further job losses as Countrywide, the biggest US mortgage lender, said it would cut 900 jobs and Lehman Brothers, the investment bank, announced 850 job cuts at its mortgage operations in the US, UK and Korea. Both groups had made earlier cuts in response to the mortgage crisis. There were signs of appetite for risk, with AstraZeneca, the drugs company, seeing strong demand for $6.9bn of bonds it issued to repay some US commercial paper.