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Central banks scale back dollar lending operation as demand drops

Four of the world’s major central banks have further reduced the U.S. dollar liquidity they offer through emergency swap lines with the Federal Reserve, in the latest illustration of the global financial system’s recovery from the market panic caused by the coronavirus early this year.

The European Central Bank, Bank of England, Bank of Japan and Swiss National Bank said on Thursday they would only offer short-term dollar funding through the Fed’s swap lines once a week , instead of three times, because “improved financing conditions in US dollars and weak demand” in recent auctions.

It’s the second time central banks have scaled back their efforts to channel cheap dollars to their national economies. In June, they reduced daily auctions to three times a week.

“This move is a sign of the success of these operations,” said Kamakshya Trivedi, currency strategist at Goldman Sachs in London.

The American central bank restored swap lines in March for the first time since the financial crisis, after global demand for the greenback jumped at the start of the pandemic and caused the currency’s exchange rate to soar. AT appease markets, the Fed provided dollars to foreign central banks directly in exchange for their local currency.

The intervention played a important role by slowing the surge in the dollar’s exchange rate and mitigating the liquidation of stock markets.

Since its peak in March, the dollar has fallen around 12% against a trade-weighted basket of currencies, according to Bloomberg, and it has fallen to its lowest level since 2018 against the euro.

“The mere existence of precautionary liquidity arrangements has a calming effect on investors,” ECB executive directors Fabio Panetta and Isabel Schnabel said in a blog post earlier this week. “This move ultimately improved market sentiment, leading to a dramatic drop in US dollar financing costs.”

As the tensions in the global financial system have eased, request for US dollars fell. The total value of the Fed’s outstanding swap line loans fell from a high of $ 449 billion in May to less than $ 100 billion – mostly on loan to the Bank of Japan.

The ECB has had no bidders for six of the nine short-term dollar liquidity operations it has conducted since the start of the month. The Bank of England has not had any loans outstanding on the Fed facility for almost a month.

Mr Trivedi said the cost of accessing short-term funding in dollars had normalized in emerging and developed economies, making it likely that use of the facility would be further reduced in the coming months.

Central banks have said they will continue with their weekly US dollar liquidity offers with a maturity of 84 days. They added that they “are prepared to readjust the provision of US dollar liquidity as market conditions warrant.”

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