The Federal Reserve and other central banks from developed countries said Wednesday they will provide liquidity to the global banking system to ease strains on European financial markets. The Fed released a statement: “These central banks have agreed to lower the pricing on the existing temporary U.S. dollar liquidity swap arrangement by 50 basis points so that the new rate will be the U.S. dollar overnight index swap rate plus 50-basis points.” The lower pricing begins on December 5. Since the current economic crisis began, the Federal Reserve became the ad hoc lender of last resort. A white paper released two years ago from the Bank for International Settlements credited the Fed’s role as central to avoiding an even greater restriction in global liquidity. The Fed said its authorization of the swap arrangements has been extended to February 1, 2013. In addition, the Bank of England, the Bank of Japan, the European Central Bank and Swiss National Bank are expected to offer three-month tenders until they provide notice of a change. “As a contingency measure, these central banks have also agreed to establish temporary bilateral liquidity swap arrangements so that liquidity can be provided in each jurisdiction in any of their currencies should market conditions so warrant,” the Fed said. The wider implication to the Fed move shows that difficulties in Europe are spreading to U.S. dollar investors in foreign markets. As the Eurozone deteriorates further, these investors continue to gravitate to dollar deals. The Fed and central banks are filling the need for dollars with these swap arrangements in order to ensure overnight liquidity to the weakened European banking sector. “At present, there is no need to offer liquidity in non-domestic currencies other than the U.S. dollar, but the central banks judge it prudent to make the necessary arrangements so that liquidity support operations could be put into place quickly should the need arise. These swap lines are authorized through February 1, 2013,” the Federal Reserve added. However, tapping the ECB’s deposit window would likely be taken as an admission of weakness in the European bank mentality, and this option is therefore unlikely to be greatly utilized unless the European Central Bank lowers the cost of lending. The Federal Open Market Committee extended the existing temporary U.S. dollar liquidity swap arrangements that it has with the Bank of Canada, the Bank of England, the Bank of Japan, the European Central Bank and the Swiss National Bank through Feb. 1, 2013. The Fed said in a statement, “The rate on these swap arrangements has been reduced from the U.S. dollar OIS rate plus 100 basis points to the OIS rate plus 50 basis points. In addition, as a contingency measure, the Federal Open Market Committee has agreed to establish similar temporary swap arrangements with these five central banks to provide liquidity in any of their currencies if necessary.” Write to Kerri Panchuk. Additional reporting by Jacob Gaffney.

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