Press Release Summary: Last week the credit crunch continued to dominate headlines with banks and housing stocks being hit the hardest. The Bank of England's Governor King alluded to the situation being akin to a 'run on the banks'. Specifically he was referring to the situation whereby major banks are withholding funding in the asset backed commercial paper market. LIBOR, the rate at which banks are willing to lend to each other rose to a nine year peak last week. The three month lending rate at one point rose to more than 100 base points above the Bank of England's target rate.
Press Release Body: The bank of England eased the situation somewhat by relaxing restrictions on the amount of money financial institutions need to hold with the central bank, encouraging them to lend more to each other. Libor dropped for the third straight day on Friday, but overnight on Thursday there was a severe reminder of just why banks were being so wary in lending to each other. Northern Rock's fresh profit warning and surprise move to tap the BoE for emergency funding spooked investors further.
Governor King predicted that banks would move to the more traditional model of funding lending through deposits. As a reflection of this, some banks have increased the interest offered in their deposit accounts, but at the same time have increased the rates charged to mortgage borrowers.
The BoE hinted that if the situation worsens it may act with an interest rate cut. Until then, with borrowers being hit with a de facto rate hike, it may not be long before the credit crisis expands to the wider economy. We will know more about this next week with the minutes from the last MPC meeting being released on Wednesday and retail sales data on Thursday.
Tuesday 18th of September 18.15 GMT sees one of the most important FOMC interest rate statements in recent history. It is likely that markets will grind to a halt coming into the decision and then unwind like a coiled spring on the announcement. The US Federal reserve has come under intensive pressure from Wall Street to cut rates to ease the credit crisis.
Yet it is not an easy decision to make, the US housing market has been in severe decline for a while and householders at the thick end of the sub prime crisis will no doubt be grateful for a rate cut. On the other hand inflationary pressures do remain. Oil continues to surge to record highs and commodities such as wheat have risen spectacularly in recent months. The latter even prompted a 'pasta protest' in Italy, with Italians calling for the government to do something about the spiraling cost of the national dish. Wednesday's US housing starts data and Bernake's speech on Thursday will both influence an excited market post rate decision.
Traders at Betonmarkets.com believes that predicting the market in the short term is near impossible as it so much depends on the US rate decision and accompanying statement next week. The quarter point cut is the more likely option for the moment, but even if this is how it pans out, the potential for another cut at future meetings will be equally market moving. If you were willing to trade in the face of so much uncertainty, a volatility play may be the better option with markets expected to move considerably on Tuesdays announcement in the US. A 14 day up or down trade trades returns around 10% on the S&P 500 with the triggers set as 1420 and 1525. If the market touches either of these levels within the next 14 days you win.
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