Subprime fallout heightens global rate doubts

Reports of fresh damage from the teetering US subprime mortgage sector provoked financial market wobbles yesterday as central banks around the world said their interest rate intentions had been thrown into doubt.

The European Central Bank, Bank of Japan and Bank of Canada all said market turmoil could affect their monetary decisions, leaving a Friday speech by Us Federal Reserve Chairman Ben Bernanke firmly in the spotlight.

Reports that more financial institutions faced problems, and evidence that German confidence had taken a knock, followed Monday data which showed the inventory of unsold single-family properties in the US soared last month to the highest in more than 15 years.

German business sentiment fell in August as firms took a dimmer view about the coming six months following recent market turmoil, the Munich-based Ifo economic research institute's closely watched survey showed on Tuesday.

"The expectations are still positive but not as in previous months. The situation of financial markets has certainly played a role in this," Ifo chief economist Gernot Nerb said.

Germany has borne the brunt of the European fallout from problems stemming from subprime US home loans as two of its banks have almost collapsed, requiring major bailouts.

Britain's Times newspaper said institutional money manager State Street faced $22 billion exposure to asset-backed commercial paper conduits - packages of retail and commercial loans financed by short-term debt raised in the commercial paper market - that have caused problems for rivals in recent weeks.

The Boston-based bank has credit lines to at least six conduits, which account for 17 per cent of its total assets, the paper said, citing regulatory filings. Barclays Bank denied a report that debt vehicles structured by its investment banking arm had left it with an exposure worth hundreds of millions of dollars.

European share prices headed south on a fresh bout of jitters as investors rushed to grab safe-haven government bonds.

"The credit story is back with headlines about banks' exposure meaning that risk aversion is back to the fore," said Ian Stannard, senior FX strategist at BNP Paribas. Uncertainty about banks' exposure to the US subprime market was matched by doubts about the direction of monetary policy.

ECB President Jean-Claude Trichet cast fresh doubt on the chances of a euro zone rate rise next week, noting that his last comments on monetary policy on August 2, when he used the "strong vigilance" phrase signalling tightening was likely, came before the current period of market volatility. Some Bank of Japan policy board members also expressed concern about the risks of US subprime mortgage problems spilling over to global financial markets, minutes of their July 11-12 meeting when they left rates on hold showed yesterday.

"We now expect the BOJ could raise rates in November at the earliest because it will take the bank another couple of months to see how the subprime loan problems may affect the real economy," said Masaaki Kanno, chief economist at JPMorgan Securities Japan.

The Bank of Canada said risks to the Canadian economy had risen as a result of world credit market turmoil, adding this would be taken into account at a September 5 interest rate review.

The central bank said last month when it raised interest rates that some modest further increase might be required, but Deputy Governor Pierre Duguay said on Monday: "Given recent events in global credit markets, we need to assess the extent to which the risks around our July projections have shifted."