Borrowing Costs Fall to Lowest Level in 5 Months

The rate at which banks lend dollar funds to each other fell on Tuesday, most notably for periods of a month or longer, pushing benchmark three-month borrowing costs to their lowest in five months.

The London interbank offered rates (Libor) for three-month dollar funds at the British Bankers' Association's daily fixing was 2.70625 percent, marking the 17th consecutive daily decline and the lowest since June 9.

Euro and sterling Libor rates also fell but by smaller margins, suggesting the thawing of frozen money markets remains more concentrated in dollars.

The dollar Libor/OIS spread -- the closely-watched premium paid for interbank dollar borrowing over anticipated official policy rates as measured by Overnight Index Swap rates -- narrowed much more than euro or sterling spreads too.

The dollar spread fell by around 15 basis points, while the sterling Libor/OIS spread fell only a couple and the euro spread even inched a notch wider.

The flood of dollar liquidity pumped into the global banking system after the collapse of Lehman Brothers in mid-September, together with aggressive interest rate cuts around the world, have calmed the panic and eased the worst of the credit crisis.

But the European Central Bank said on Tuesday banks deposited a record 280 billion euros at the central bank overnight on Monday, suggesting banks would still rather park cash at the ECB for low return than lend out.

And analysts note that the fall in dollar spreads is being driven both by falling official rate expectations (OIS) as well as notable outright falls in Libor term rates.

In Europe, any moderation in spreads appears to be driven largely by falling OIS, while Libor remains much more sticky.

"Term lending premia remain at very elevated levels -- in Europe, still close to their post-Lehmans-collapse highs," ICAP strategists said in a note on Tuesday.

"In contrast, for U.S. dollars the fall back in Libor rates has been driven by a re-narrowing of term interbank lending premia, but this has occurred from extremely elevated levels."

Europe Lagging?

On Tuesday, the BBA daily fixing showed that the biggest declines in Libor rates across the three major currencies were in one- two- and three-month dollars, which fell by up to 18 basis points.

Overnight dollar Libor was fixed at a paltry 0.37500 percent , less than half the Federal Reserve's 1 percent target for overnight federal funds.

The dollar Libor/OIS spread narrowed to around 210 basis points from around 225 basis points, the smallest gap since late September shortly after Lehman Brothers went to the wall.

"The present (dollar) spread is still twice as large as it was after Lehman closed its doors, but the improvement brought about by the stepping-up of official intervention is still significant," said Laurence Mutkin, head of European rates strategy at Morgan Stanley.


"By contrast, sterling and euro spot Libor/OIS spreads have barely budged during the past month. Of course, sterling and euro spreads never widened as far as the dollar spread ... but if the pace of narrowing in the U.S. continues, the sterling and euro markets will start to look like laggards," he said.

The three-month sterling Libor/OIS spread was last indicated around 226 basis points and the euro spread around 180 basis points.

Libor/OIS spreads are a closely-watched measure of the flow of credit through the financial system and broad market stress.

The premium paid for three-month dollar Libor over comparable T-bill yields -- known as the "TED" spread -- was indicated around 220 basis points, the narrowest since late September, Reuters charts showed.

In Europe on Tuesday the ECB and Bank of England injected a combined $83 billion in 84-day dollar liquidity into the financial system, and the ECB allotted $650 million in a parallel currency swap.

In other developments, the Wall Street Journal reported on Tuesday that the U.S. Treasury is considering using its $700 billion rescue fund to buy stakes in a broader range of financial companies, not just banks and insurers, including bond insurers and specialty finance firms.

And Australia's central bank slashed interest rates by three quarters of a percentage point to 5.25 percent to limit the effect of the financial crisis on the real economy, an aggressive move which some analysts say the ECB and BoE could replicate later this week.