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Trichet: Eurozone money market conditions have “progressively gone back to normal”

Market participants should “keep their composure,” European Central Bank President Jean-Claude Trichet said Tuesday, while insisting that money market conditions were returning to normal.

The European Central Bank had provided additional liquidity since Thursday last week in response to “a period of market nervousness,” Trichet said in a statement released from ECB headquarters in Frankfurt. He referred to a “significant reappreciation of risks,” and added: “In some respects, what has been observed can be interpreted as a normalization of the pricing of risk.” The ECB intervened on Thursday last week, injecting a huge €95 billion ($130 billion) into the money market, in response to tight credit in the European banking system as a result of the US subprime mortgage crisis. The overnight operation brought short-term rates in the eurozone down from a spike of close to 4.7% to the 4.00% ECB benchmark. The open market operation was unusual in that banks were allowed as much cash as they needed at 4.00%, instead of having to bid as is usually the case. It was the first time since the September 11 attacks in 2001 that the ECB had taken this kind of action. The move sparked consternation on world stock markets and was seen by analysts as having contributed to falls around the world at the end of last week, as dealers speculated the ECB might have access to information on a serious credit crunch or the failure of a major bank.

Further adds of €61 billion on Friday, €48 billion on Monday and a relatively small €8 billion ($10.7 billion) on Tuesday dampened overnight rates and helped calm markets. European stock markets rose Monday and saw only slight falls on Tuesday in response to the ECB’s operations. “We have provided in particular the liquidity which was needed to permit an orderly functioning of the money market,” Trichet said, pledging that the ECB would “continue to monitor the situation.” “I call on all parties concerned to continue to keep their composure. This attitude has been welcome and effective in the recent days. It will help to consolidate a smooth return to a normal assessment of risks in liquid markets,” he concluded. Trichet has repeatedly signaled that the ECB will hike rates at the next Governing Council meeting on September 6, and the markets have priced in a rise to 4.25% in the refinancing rate.

Earlier Tuesday, the Bank of Japan drained 1.6 trillion yen ($13.53 billion) from the banking system after adding 1 trillion yen on Friday and another 600 billion on Monday. The US Federal Reserve has also added liquidity, providing $38 billion on Friday and $2 billion on Monday. Other major central banks, with the exception of the Bank of England, have acted similarly. The leading indices on Europe’s stock markets were little changed in Tuesday trading. London’s FTSE was up 0.5%, while Frankfurt’s DAX 30 and Paris' CAC 40 were virtually unchanged in mid-afternoon trade. The Swiss SMI was down 0.3%. (