NEW YORK: The euro posted steep gains on Thursday after major central banks said they would work together to alleviate funding strains for European banks having difficulty borrowing dollars.
The move, which will provide three-month dollar liquidity, was, however, unlikely to relieve all of the stresses troubling the market due to the euro zone's sovereign debt crisis, analysts said.
The European Central Bank announced the funding operations, to be undertaken in conjunction with the US Federal Reserve, the Bank of England, Bank of Japan and Swiss National Bank.
The ECB already offers seven-day dollar loans every week, and this offer was tapped for the second time in a month on Wednesday. Previously, banks had not used the ECB's dollar operation since February.
"The news buoyed currencies against the US dollar, although the impact has started to dissipate," said Lauren Rosborough, currency strategist at WestPac in London.
"The swap agreements alleviate funding concerns in the short term, but it doesn't tackle the underlying problems, nor is it a solution to the European crisis."
Euro zone banks have faced renewed dollar funding strains recently on the back of fears a potential Greek default could hit the region's banking sector.
Analysts said the funding crunch has been going on for four months, with dollar-rich US banks reportedly requiring a 130 percent collateral for a loan to European banks.
The euro surged to session highs against the dollar at $1.39370 following the ECB news and was last at $1.38519, up 0.8 percent. Against the yen, the euro rose 0.8 percent to 106.239 yen.
The three-month euro/dollar cross currency basis swap, or the relative premium for swapping euro LIBOR for dollar LIBOR, tightened to around 89 basis points after the announcement from the ECB, narrowing from as wide as 115 basis points on Monday.
Wider spreads reflect elevated demand to borrow US dollars in the currency forward market and often support the greenback's spot value against the euro.
Alasdair Mackay, director of currency trading at Scotia Capital in London, said banks' liability managers are already under severe pressure because of the funding squeeze, but the big date to watch out for when dollar demand is expected to be high is at the end of the calendar year.
"So (the additional liquidity) allows all the central banks the ability to provide dollars to their banks should they need them. That gives the market a little more confidence that the dollar funds would be there at the end of the year."
The euro had strengthened earlier, bolstered by fresh expressions of support for Greece from Germany and France on Wednesday. It remained vulnerable, though, amid persistent fears of a Greek default.
Scotia's Mackay suggested the central bank measure may have been intended to cushion the effect of an eventual default.
"The feeling I get is that central banks are provisioning for a potential Greek default," said Mackay. "A default is inevitable at some point."
The news, events and comments made by officials in the last week have led market participants to factor in a much higher probability Greece could default over the next few months.
Lane Newman, director of foreign exchange trading at ING Capital Market, said the currency market has priced in a 90 percent probability of an 'orderly default' by Greece.
Some analysts said the central bank liquidity could limit the contagion if the default happens and effectively place a cap on funding strains that could ensue.
The dollar meanwhile jumped against the yen to hit session highs at 77.335 yen on trading platform EBS, with traders citing market talk that the Bank of Japan was checking currency rates, then subsided and was last flat at 76.860 yen.
Copyright Reuters, 2011
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