BoE offers unlimited funds in 'auto lube' system - at a price

As central banks around the world were busy announcing the injection of billions of dollars or euros into their banking systems yesterday to ensure that liquidity did not dry up, the Bank of England was notable for its silence.

Surely the Old Lady of Threadneedle Street had not fallen asleep on the job, pundits asked?

But the reason for the Bank's reticence was that last year it introduced a new money market system under which it has a permanent, unlimited standing facility available to commercial banks for them to draw on if they want to.

It charges a rate above the prevailing Bank interest rate and currently any bank wanting to use the standing facility would have to pay 6.75% for funds - one percentage point over base.

According to the Bank's latest announcement yesterday, no one had dipped into the facility at all during the frantic market activity on Thursday, although it was not clear as to whether anyone had yesterday.

The European Central Bank and US Federal Reserve, as well as a number of Asian central banks, all provided tens of billions of dollars to ensure that the wheels of the money markets did not seize up, whereas the Bank of England has in effect introduced an "auto-lube" system.

Those other central banks injected funds at below their current base rates to attract banks to use them. The Bank of England, though, sets a higher rate so banks will only use them if they really need to.

And when they do use it, the Bank of England gets a vital early warning signal about which institutions may be in trouble - information which is not available to the central banks who shower cheap money on all banks indiscriminately.

Central banks maintain a vital function in their economies by keeping the banking system working properly, ensuring the smooth lending and borrowing between banks that occurs every working day.

The Bank of England uses the money market to transmit the interest rate policy of the monetary policy committee and to meet the liquidity needs of the banking system, thus ensuring its stability.

In the current turmoil many commercial banks are worried about the effects on their balance sheets and have decided to hold more cash than they otherwise would, hence the draw on the money markets' available funds.

What prompted the interventions from the central banks was that overnight money interest rates shot up this week because cash was scarce. In other words, the price of money rose because it was in short supply.

As of late yesterday, it appeared that the massive injections of funds in the US, Europe and beyond had had the effect of pushing those overnight rates back down again, relieving the pressure on the banking system, for now at least.

Market reaction


The FTSE 100 index fell by 232 points after heavy losses on Thursday. "What we have at the moment is just an all-round sense of panic," said Marc Ostwald, bond analyst at Insinger de Beaufort. "It's going to take a while to resolve this."

United States

The Dow Jones industrial average was down 58 points in morning trading and the S&P 500 index was also down. Donald Trump, the billionaire property magnate, said: "If they don't lower interest rates, they are going to kill the golden goose which is real estate and that's going to cause all sorts of problems."


Thursday's heavy losses on Wall Street and in London led to a sell-off in the Asian markets yesterday where the Nikkei 225 average dropped 2.37% on the Tokyo stock exchange. Hong Kong's blue chip Hang Seng fell 2.9% and in Seoul, the main index was down 4.2%. But it was short-term investors who led the selling. Song Seng Wun, economist with Singapore's CIMB-GK Research, said: "There hasn't been any panic selling. The long-term people are still looking and waiting."


The mood on the Frankfurt stock exchange was jittery with observers reacting nervously to the decision of the European Central Bank to inject a further €61bn into the banking system. The DAX index fell 1.5%. In the rest of continental Europe share prices had their worst day since February. The CAC-40 index fell 3.3% in Paris where shares in Société Générale bank were down 5%.