Euribor gone mad

That is the splashy news on the website of an Italian newspaper. The Euribor spiked violently by 60 basis points to 4.87pc today, its sharpest move higher ever, to close at 4.82pc for one month and 4.81pc for three month. The rate is now higher than at the climax of the credit crises in August. The commercial paper rates are also re approaching the worst levels of the summer. Pleas are growing that the EZB will cut rates on its next meeting in December.

Thomas Mayer, Europe economist for Deutsche Bank, said the authorities should take pre-emptive action to unfreeze the debt markets and reduce the danger that events could spiral out of control. "If they don't do anything, this could go beyond just a normal recession. With this credit crisis it could turn into a very uncomfortable situation, with a real economy-wide crunch that we cannot stop," he said. "We're still seeing considerable stress in the European banking system, especially for smaller banks that can't get credit. I am afraid we could have another Northern Rock case," he said. It emerged today that Germany's IKB bank had racked up losses of €6.15bn on subprime ventures, although it has been rescued by a pool of German banks.
Veronique Riches-Flores, Europe economist at Société Générale, said investors were deluding themselve if they believed that Europe and the rest of the world could carry on growing briskly as the housing slump engulfed America. "The idea people have in mind that emerging markets can decouple is completely wrong. Emerging markets are only OK as long as the US consumer is OK," she said. Joachim Fels, head of economic research at Morgan Stanley, said it was an error to dwell on inflation at time when the economy is tipping over, dismissing the latest spike as a hangover effect that would subside next year. The greater risk is monetary overkill. The surge in Euribor spreads amounts to three rate rises, he said.

Banks in Europe are obviously reluctant to lend to each other. One can only speculate about the exact reasons. Back in August the first signs that the credit problems in the US were spilling over to Europe could be seen in the currency markets. The euro was depriciating against the dollar and the yen. On August 10 the European Central Bank loaned 61.05 billion euros ($83.6 billion), pumping funds into the banking system for a second day after U.S. subprime mortgage losses rippled through credit markets and drove interest rates higher. BNP Paribas announced that it is freezing redemptions in three asset backed securities funds due to inability to fairly value their holdings. The seizure of the credit markets ironically enough benefited the US dollar, the epicenter of the sub-prime mess, as the greenback would become bid on safe haven flows.
Could the freeze up in interbank European markets be behind the sudden reversal of the faith of the dollar rather than the pick up of economic growth in the future, as suggested by some dollar centric pundits today? It strikes me as rather odd that the dollar would appreciate on a day when FED chief Bernanke makes it certain that further rate cuts are coming.

British Blogger Macro Man in his recent post "Double Whammy" had an interesting take on the dollar today, citing the cover of magazines as good contrarian indicators.