This has contributed to the financing of the economy and has helped to contain the impact of the crisis on economic activity and price developments. The spread between the three-month unsecured money market rate, Euribor, and the three-month overnight index swap rate (Eonia swap rate), a widely-used measure of interbank market tensions, declined by almost 130 basis points over the past seven months, from the highs of above 180 basis points recorded in October 2008 to just below 60 basis points in mid-May 2009. 6 Moreover, the levels of money market rates have declined even more from the peaks reached last October. For example, the three-month Euribor rate was 1.26% at the beginning of this week (26 May), more than 400 basis points lower that its peak value (5.39%) last October. Moreover, the increasing transaction volumes in the unsecured interbank market and the lower utilisation of the ECB’s deposit facility indicate that market liquidity has improved significantly. It is sometimes claimed that money market conditions in the euro area are considerably tighter than in other major money markets. The facts disprove such assertions. The current levels of interest rates in the euro money market compare very favourably with the levels of the corresponding interest rates in the dollar and pound sterling money markets, where interest rate spreads and levels have also declined sharply over the past few months.
In order to restore an adequate flow of credit to the economy, banks should take advantage of governments’ commitments to support banks’ balance sheets through capital injections, the provision of government guarantees on new bank debt, as well as through asset relief schemes aiming at removing troubled assets from banks’ balance sheets. The common goals of these government measures in Europe and elsewhere are to safeguard financial stability, help restore the provision of credit to the economy and bolster confidence in the soundness of the financial system and in the prospects of the economy. Needless to say, the ongoing structural adjustment in the banking sector and the low confidence of investors in the soundness of some institutions cannot be counteracted by monetary policy and the provision of central bank liquidity. IV. Bank support measures and fiscal stimulus  At present, the European economy is experiencing a mutually reinforcing interaction between, on the one hand, the weakening of economic activity and rising unemployment, and, on the other hand, the deleveraging of banks’ balance sheets and the persisting bank stresses in some bank funding markets. The deleveraging process and the emergence of an adverse feedback loop between the real economy and the financial sector will affect the favourable impact of monetary policy and liquidity provision on the economy. These developments underscore the importance of effective implementation of the government measures to strengthen bank balance sheets and improve banks’ medium-term market funding.