Chapter 15 outlines why and when a Central Bank might want to Sterilize the effects of Balance of Payments imbalances.

The case seldom considered is that such sterilization might actually fail, because the public is simply not willing to lend to the central bank at the prevailing interest rates. This just happened in Europe at a grand scale. Perhaps that is not surprising, the markets are clearly predicting an imminent Greek default (aka "restructuring" or "haircut").

CRISIS IS BACK WITH A VENGEANCE AS ECB’S STERILISATION AUCTION FLOPS

After a brief lull, during which the crisis seemed almost forgotten, the financial market reverted to crisis…

One of the reasons for the panic was concern about the state of the European banking system, and the surprising news was that the ECB’s €55bn fixed-term deposit flopped spectacularly, as it managed to managed to raise only €31.866bn at an average interest rate of 0.54%. This means that financial institutions continue to hog liquidity.

The  FT reports on new turbulences in financial markets, as the ECB’s decision not to renew one-year loans to financial institutions spooked investors and prompted concerns about the ability of some eurozone banks to access interbank borrowing markets for funding.  Financial shares dropped 4.5%, European interbank borrowing rates jumped to the highest level for nine months and the euro reached lowest exchange rate level against the yen for the last eight years.

The cost of insuring Greek government debt is now second only to that of Venezuela,Bloomberg reports. Credit swaps signal there’s a more than 67 percent chance Greece won’t meet its commitments within the next five years. Greek government bonds have now overtaken Argentina. Greek debt was 115% of GDP last year, compared to 60% for Argentina when it defaulted. 

Europe widens stress tests

The Wall Street Journal’s Brussels blog reports that some more details on the stress tests for European banks have now been settled. The scope of the tests will be widened from 26 banks to 60-120 banks, including Landesbanken and Cajas. The tests will incorporate banks in all countries. The results will be released on a bank-by-bank basis. The banks will be tested for sovereign default. All tests to be completed by mid-July. Last year’s forecast mistakes will be taken into account.