Fed pumps $8bn into market to head off new crunch

Central bankers are becoming nervous that a renewed credit crunch could destabilise financial markets around the end of next month, and the US Federal Reserve has pumped an initial $8bn (£3.9bn) into the market to help ease the mounting pressure.

Wall Street banks have been hoarding cash rather than lending it out, fearful that losses on US mortgages and related products are undermining the strength of their balance sheets.

And the Federal Reserve said that the problem could become acute before 31 December, when many institutions close their books on the financial year and when many important accounting calculations are made.

In a highly unusual move, the Federal Reserve Bank of New York said yesterday that it was putting an additional $8bn into the financial system through 43-day loans, money that won't have to be paid back until 10 January. The duration of the loans is substantially longer than that in normal market operations by the Fed.

If Wall Street's banks become unwilling or unable to lend to each other, there could be knock-on consequences throughout the financial system, with high street lenders and other businesses finding it impossible or punitively expensive to find the short-term money required to fund their operations. It was just such a credit crunch that led to the problems at Northern Rock at the height of the crisis in the summer.

Investors fled commercial debt in favour of the perceived safety of US government bonds. The yield on the benchmark 10-year Treasury fell below 4 per cent to 3.81 per cent, its lowest level in more than two years. Wall Street also took another lurch downwards, the Dow Jones Industrial Average sliding 237.4 to 12,743.4.

The Fed announced its move yesterday "in response to heightened pressures in money markets for funding through the year-end", and it promised to add more than the initial $8bn. It also said it stood ready to pump further shorter-term funds into the market if there was upward pressure on overnight interest rates.

Bond traders have become concerned that spreads on many debt instruments have widened again, reflecting renewed reluctance to hold risky assets and erasing some of the benefit of the Fed's two interest-rate cuts since the summer. Short-term money market rates are accelerating up across the world. Three-month Libor, the closely watched rate that banks charge each other for lending in euros, climbed for the ninth session in a row yesterday and posted its biggest one-day jump since the credit crisis erupted in August.

The growing anxiety prompted the European Central Bank to repeat a promise it first made last Friday, that it would act to head off a year-end crunch.