The move is the first by the U.K. central bank to help credit markets since the U.S. subprime mortgage market collapsed. Governor Mervyn King yesterday indicated the bank won't go as far as the European Central Bank and the Federal Reserve in helping banks cope with the credit rout because policy makers can't afford to ``encourage excessive risk-taking.''
``Today's operations do not represent an underwriting of risky lending but a logical move to help the efficient functioning of the U.K. money markets,'' said Philip Shaw, chief economist at Investec Securities in London.
Commercial banks, which agree to hold a specific amount of money at the Bank of England at the end of each month-long maintenance period, can now undershoot that target by 37.5 percent to free up cash if needed. That compares with the usual limit of 1 percent.
The Bank of England also added a net 3.9 billion pounds ($7.9 billion) to money markets in its weekly market operation today.
The overnight rate for pounds fell 3 basis points to 5.87 percent after the announcement. It rose as high as 6.5 percent on Aug. 13. The three-month London interbank offered rate, or Libor, declined 1 basis point to 6.89 percent, still near its highest since 1998. The Bank of England's benchmark is currently at 5.75 percent.
Activism
The bank's response contrasts with the more activist approach of the ECB and the Fed. The ECB has loaned cash to banks in seven special auctions since Aug. 9. The Fed last month cut its discount interest rate and abandoned its bias towards fighting inflation.
The ECB has nevertheless struggled to get market rates under control. The three-month Libor for euros held near a six-year high of 4.73 percent today, which compares with the bank's benchmark rate of 4 percent.
``By not pumping the market full of liquidity as the ECB and Fed have done, to little effect if three-month Libor rates are a guide,'' the Bank of England ``also sticks to the line that they have taken on moral hazard,'' said Marcus Ostwald, a fixed-income strategist at Insinger de Beaufort SA in London.
The bank today widened the reserves target for the first time since the current system for dealing with market turmoil was introduced in May last year.
King yesterday refused to deviate from those rules and rejected calls to provide commercial banks with more longer-term cash to reduce borrowing costs.
``The provision of such liquidity support undermines the efficient pricing of risk by providing ex-post insurance for risky behavior,'' King said in written testimony to the U.K. Parliament's Treasury Committee. ``That encourages excessive risk- taking, and sows the seeds of a future financial crisis.''
The bank today allocated 38.4 billion pounds at its benchmark rate as 34.5 billion pounds matured. Banks bid for a total of 182.9 billion pounds. That compares with 179.7 billion pounds a week ago and 79.2 billion pounds on Aug. 2, before the credit market slump.
