Central banks join forces to ward off credit crunch

Stock markets soar as investors welcome co-ordinated action to boost liquidity

The US Federal Reserve and other major central banks increased their efforts to stave off another credit crunch yesterday by acting in concert to give lenders access to funds they need as the European sovereign debt storm rages on.

The Fed, along with the European Central Bank, the Bank of England, the Bank of Canada, the Swiss National Bank and the Bank of Japan, said they would slash the cost to banks of securing US dollars by 50 basis points. The emergency action, which is reminiscent of the aggressive steps taken by the world's top monetary bodies during the financial crisis, is aimed at ensuring that lenders do not fall prey to another credit crunch as conditions in the wholesale markets deteriorate.

The move will make it easier for troubled European banks, which have been finding it harder to tap the wholesale markets amid concerns about their exposure to European sovereign debt, to access the US dollar funds they need to go about their business.

But the central banks went further: the action to provide easier access to US dollars was accompanied by measures to set up temporary mechanisms that will allow them to provide funds in any of their other currencies, "should market conditions so warrant".

"Once again, the world's central banks are being forced to move aggressively to counter a crisis that has grown in scale and scope because of inadequate policy responses on the part of other agencies," the chief executive of the giant bond manager Pimco, Mohamed El-Erian, said.

News of the intervention, which follows other measures to increase liquidity earlier this year, led to a sudden change in mood among investors. After selling for much of morning – a response to ratings cuts for numerous banks and to overnight plans from European finance ministers to increase the firepower for the European Financial Stability Facility (EFSF) – they rushed back into the stock market, the FTSE 100 soaring by more than 3 per cent. The German market was up by nearly 5 per cent, while Italy gained more than 4 per cent yesterday.

But although stock markets soared, the cost of borrowing for Italy and Spain remained around levels that are widely viewed as unsustainable in the long term. Ahead of the co-ordinated action on US dollar funding, the Italian central bank announced measures to help cash-starved Italian lenders.

And although the global efforts to boost bank liquidity were welcomed, the inability of ministers in Brussels to specify by how much they would increase the capacity of the EFSF led to uncertainty and disappointment in the market. Initially, the currency block's €440bn (£337bn) bailout fund was expected to be raised to €1 trillion with the involvement of investors, but the recent deterioration in market conditions means that Europe may have to turn to the International Monetary Fund for extra help.

There were also renewed calls for deeper integration to safeguard the embattled eurozone. "The economic and monetary union will either have to be completed through much deeper integration or we will have to accept a gradual disintegration of over half a century of European integration," the EU's economic and monetary affairs commissioner, Olli Rehn, told the European Parliament yesterday.