A mounting threat of a severe end-of-year cash squeeze in credit markets triggered by renewed hoarding of funds by nervous banks prompted fresh action yesterday by the US Federal Reserve and the European Central Bank (ECB).

Amid growing fears of a new and painful bout of credit market turmoil as banks stockpile capital to allay their worries over balance sheet strains, the Fed and the ECB sought to promote calm with a pledge to inject extra funds into money markets.

The moves by the world’s two most powerful central banks came as yet more sharp increases in market interest rates for lending between commercial banks on both sides of the Atlantic emphasised the resurgence of stress in the markets.

In London, three-month Libor rates for funds in the euro yesterday marked their biggest single-day jump since the credit crisis began in August, while two-month euro rates stood at their highest since 2001. For dollar funds, both two-month and three-month Libor rates were at their highest in a month.

The Fed said that tomorrow it would offer $8 billion (£3.9 billion) in extra capital to US banks through a loan facility for repayment in January, in what it said would be the first of a series of injections of additional liquidity. The Fed also said that it would lift the amount of funds available to individual banks.

In addition, the Fed’s open market trading desk is to provide extra reserves to resist upward pressure on overnight rates around the year-end – the first such operation that it has undertaken since December 8, 2005.

“Given the high level of attention focused on the coming year-end, we hope to reassure market participants of our commitment to providing sufficient balances at that time,” a senior Fed official said.

The Fed’s action came as the ECB renewed a commitment it gave late on Friday to provide extra funds to markets. Lucas Papademos, the ECB vice-president, sounded a warning that it appeared that “the ongoing process of risk reappraisal and repricing in financial markets could be more protracted than previously expected”.

Citigroup, Wall Street’s biggest bank, said that “strains in core financial markets appear to have intensified”, but concluded that “current stresses will not overwhelm the world economy”.

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