China, EU reassure on subprime fallout

  @ibtimes on September 03 2007 11:41 AM

China said on Monday none of its massive foreign exchange stockpile was invested in the teetering U.S. subprime mortgage sector, while a top EU official predicted the crisis would not choke off economic recovery.

European Union Economic and Monetary Affairs Commissioner Joaquin Almunia told newspaper El Pais lower credit growth and tighter credit conditions were very possible but that Europe's economic recovery would continue.

There is no reason that financial turbulence ... will put an end to a phase of economic recovery which is solidly based, he said.

A senior Chinese foreign exchange agency official helped sentiment by saying none of Beijing's $1.33 trillion stash of foreign exchange reserves -- the world's largest -- was in U.S. subprime mortgage-backed securities, underscoring China's earlier assertions that it had only limited exposure.

We have no holdings of U.S. subprime securities, Wei Benhua, deputy head of the State Administration of Foreign Exchange, told reporters on the sidelines of a forum.

China's towering forex reserves and current account surplus are now a key cog in the global economic wheel. Any damage there would inflame fears that the U.S. mortgage crisis could threaten wider economic tumult.

Analysts say China's capital controls have helped insulate it from the liquidity crunch, sparked by mass defaults on U.S. home loans stemming from aggressive lending mainly to poor people who have been squeezed as interest rates climbed.

European shares rose for a fourth consecutive session as hopes of a near-term U.S. rate cut firmed after Federal Reserve Chairman Ben Bernanke said last week he would take any steps needed to shelter the economy from a global credit squeeze.

But Germany's IKB, the first European victim of the credit turmoil, gave a reminder the crisis had not blown out, saying it expected to lose nearly $1 billion this year.

The lender to German companies said it was striving to stabilise future revenues but they would be significantly lower than in previous years, after its subprime mortgage investments turned sour, prompting a 3.5 billion euro rescue by other German banks.

The chief executive of Deutsche Bank, Germany's biggest bank, said global economic growth would take a hit.

Growth, especially of private consumption in the United States, will suffer because of the housing crisis and that can naturally not go without negatively affecting the world economy overall, Josef Ackermann said in a guest column published in the German business daily Handelsblatt on Monday.

ECB ON HOLD, FED TO CUT?

The European Central Bank is no longer expected to raise rates when it meets on Thursday, because of the market turmoil.

A Reuters poll last week showed 62 of 82 economists expect euro zone rates on hold at 4 percent. Economists put the chance of a hike at 40 percent, compared with 75 percent two weeks ago.

The London interbank offered rate for three-month sterling deposits hit a fresh 8-1/2 year high, while euro rates for the same period set a 6-year peak, buoyed by strong cash demand from financial institutions which showed liquidity remained tight.

The U.S. spotlight will now turn to the August employment report, due on Friday, which could further bolster expectations for a Fed rate cut.

Weakness in the data will be seen as proof that finally the housing crisis is affecting the real economy, while any strength in the data will probably ... not be taken too seriously, said Michael Klawitter, currency strategist at Dresdner Kleinwort in Frankfurt.

One of America's most prominent economists warned on Saturday that the weak housing market could topple the United States into a full-blown recession.

Lower interest rates now would help, said Martin Feldstein, president of the National Bureau of Economic Research. He warned of a multiplier effect from declining home prices and lower consumer spending, and said a rate cut of as much as 100 basis points might be warranted.

A senior advisor to President George W. Bush, who on Friday promised measures to help struggling homeowners refinance their mortgages, told the Financial Times newspaper markets would in any case find a way to solve the subprime debt crisis.

I believe, and I think the president believes, that markets are very good at finding their ways to solve problems, said Ed Lazear, head of the White House council of economic advisors.

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