ANNUAL REPORT 2008 - Polymer Bank Notes of the World

market tensions, particularly for longer maturities, as well as increases in market expectationsregarding the future path of key ECB interest rates, which were at the time more pronouncedfor the latter part of 2008 and thus had a greater impact on rates with longer maturities. Securedrates continued to be broadly stable, with the result that the spread between unsecured andsecured rates was again determined mainly by the behaviour of unsecured rates. This period sawgreater volatility in the EONIA and an increased need for liquidity provided by the Eurosystem,as suggested by the higher marginal rates in the main refinancing operations. The continuation ofthe Eurosystem’s liquidity measures helped to address these needs to a large extent.The period from June to September 2008The period between mid-June and mid-September 2008 was, overall, a period of stability inthe markets. Further events related to financial stability in other major economies (such as theUS government takeover of government-sponsored enterprises Fannie Mae and Freddie Mac on7 September) did not trigger any agitation in money markets. Unsecured markets, albeit stillstrained, were more stable, while a slight increase tended to be observed in interest rates in thesecured markets, in line with the Governing Council’s decision to increase the minimum bid ratein the main refinancing operations to 4.25% on 3 July. As a consequence, the spread betweenunsecured and secured rates at the three-month horizon declined, but did not reach the low levels ofJanuary and February. The EONIA enjoyed a period of low volatility from July until the beginningof September, when tensions resurfaced prior to the events of mid-September.The period from September 2008 onwardsA more troubled period started in mid-September, strongly affecting the behaviour of moneymarkets until the end of the year. There was a resurgence in tensions, which reached unprecedentedlevels in mid-September, when, in the space of a few days, the markets witnessed the sellingoffof Merrill Lynch and the bankruptcy of Lehman Brothers (two of the four remaining globalinvestment banks), the US government’s provision of emergency liquidity to AIG, the biggestUS insurance company, and the seizing by federal regulators of Washington Mutual, the largestsavings and loan association in the United States. In October spillover effects were felt morewidely in the euro area, while money markets suffered further tensions as a result of a sharpslump in equity markets amid the deteriorating macroeconomic environment.Market tensions intensified significantly and credit risk premia increased to levels above thoseseen previously during the period of financial turmoil. Unsecured market rates, especially forshort maturities, rose sharply after the failure of Lehman Brothers as the effects of that defaultcascaded through the euro area banking system. The implied volatility derived from options onthree-month EURIBOR futures, which experienced a prolonged period of decline from Marchto September, increased dramatically in mid-September and reached unprecedented levels inOctober (see Chart B).The Eurosystem acted quickly and decisively in response to the acute reintensification of the turmoil.The Governing Council made a number of temporary changes to its liquidity implementationframework, aimed, in particular, at strengthening its intermediation function and reassuring themarkets about liquidity risks. Specifically, on 8 October the Eurosystem took the exceptionaldecision to temporarily conduct its main refinancing operations as fixed rate tender procedureswith full allotment at the main refinancing rate and to reduce the corridor formed by the standingECBAnnual Report200833