With just over two months to go before 11 countries join a common currency, monetary authorities say the uncertainties associated with the euro's introduction could lead firms to curb sharply their trading activities ahead of January 1.

"Liquidity may... be in short supply at this time (as) some firms intend to reduce activity... in order to simplify their conversion weekend processing," the Bank of England said in a report sent to the European Commission in late September.

"It is not yet clear what the full market consequences of such a development might be: This would depend on how many firms took such an approach and the consequent reduction in volumes involved," the Bank added.

The so-called conversion weekend, stretching from December 31 to January 4, will be a period of great stress and anxiety for banksand investment firms who have only a few days to make sure they are ready to trade in the new currency.

Computer and dealing systems will be revamped to incorporate the conversion rates for national currencies into the euro. In addition, there is the arduous task of redenominating government bond positions for all 11 countries.

The potential for things to go wrong is great and with global markets in a fragile state the desire to sit on the sidelines and avoid any added trouble is seen as natural and understandable.

"I think right now people are much more alert about liquidity and credit than if you would have spoken to them three months ago," said the head of fixed income trading at a US investment bank. "That has nothing to do with the euro, but the fact that you now have one more obstacle to get over, I think people are going to be that bit more cautious."

The Federal Reserve's surprise rate cut last week underscored the worries authorities have with the instability of financial markets and thegrowing caution among lenders.

New York Federal Reserve Bank president William McDonough recently summed up the Fed's concerns by saying: "There has been an excessive shift possible credit crunch are in capital markets, specifically in fixed-income markets."

The unprecedented nature of launching the euro in such an unstable environment has led to the realisation that contingency plans are mandatory, not only for individual banks and payment systems but also for central banks.

The one area where a liquidity squeeze is considered most likely is in Europe's securities repurchase market, where the annual turnover is estimated to be more than $50 trillion according to the International Securities Market Association.

The risk of a so-called squeeze in repos has much to do with the complexity of converting trades into a single currency.

"The conversion of pending repo activity from national currencies to the euro is more complex for many firms' internal systems than the conversion of pending cash trades,"the BoE said in a recent public report on euro preparations.

This is because any change to a repo trade's details has to be replicated back to the original transaction. Repos are often rolled over and the recommendation from market associations is to avoid having to unwind a series of linked repo trades on January 4, 1999 -- the first day of euro trading.

The Broker Group/ISMA Repo Sub-Committee has agreed three options for firms in dealing with their repo trades, each dependent on their scale of business and internal computer systems.

The repo is not changed over the conversion weekend. Two further outright trades are booked over the weekend for the same value as the maturity of the repo. One outright trade exactly offsets the repo trade in the national currency, while the other reflects settlement in the euro.

The repo trade in the national currency is "closed out" over the conversion weekend. A new trade is booked, but converted into the euro. The maturity date for the new repo is the same as theoriginal repo.

The repo trade is left in the national currency until the maturity date.

The group also recommends that any "open-ended" trades be converted to so-called term transactions, essentially specifying a maturity date. This would allow for a smoother conversion process.

Dealers said the unwinding of large trading positions by hedge funds which have been battered by the global crisis might also exacerbate a liquidity squeeze.

"I think in light of all the volatility in the last couple of months, my guess is that positions would be a lot smaller than they would have been otherwise," said the head of a repo trading desk at a US investment bank.

"And when you look at the hedge funds probably winding down, that leaves even fewer positions in the market."

To combat any severe liquidity shortfall, bankers say they are increasingly confident the European Central Bank, acting together with national central banks, would intervene in the markets and supply necessary funds.

"We encouraged (the ECB)to take active measures to provide extra liquidity in and I think they are planning to do that," said one London banker who met the Bank recently.

"They dropped a couple of broad hints that there are a few measures they could take that will provide safeguards in the event that we do get into difficult liquidity problems."

With pressure building from the financial community and authorities such as the BoE, bankers said there was now sufficient concern at the ECB over the risks involved during the conversion weekend and recognition that it must play a leading role in developing contingency plans.

The reluctance of the ECB to take a more active approach stemmed in part from the desire not to appear heavy-handed with national central banks before they take over the policy reins on January 1, 1999.

Moreover, the legal remit of the ECB has been narrowly defined by the Maastricht treaty, a criticism many economists are now highlighting, particularly on issues of banking supervision and as a lender of lastresort.

Bankers said they expect the ECB to announce its contingency plans for the conversion weekend sometime in November.