Global bank rates slip, thaw may have hit plateau

LONDON/NEW YORK (Reuters) - Banks trimmed most lending rates to each other on Friday but their declines were some of their smallest this week, suggesting the improvement in global money markets may have run its course.

Risk premiums spiked for some market rates as a dramatic equity sell-off worldwide revived concerns about counterparty risk, but some analysts downplayed the move as an indication traders are pricing in steep central bank rate cuts.

Most borrowing costs for dollars, euros and sterling in the unsecured interbank lending market in London were flat to 7 basis points lower than Thursday.

The spreads or risk premium on three-month Libor above anticipated central bank rates, seen as a gauge of banks' willingness to lend to each other, widened more than 10 basis points. The three-month dollar Libor/overnight Index Swap (OIS) spread widened for the first time in a week.

Traders blamed the wider spreads on the flood of forced stock sales in overseas markets and anxiety after data showed the British economy contracted.

The rise in risk premiums was also a result of a sharp fall in OIS rates as traders factored in deep rate cuts from key central banks, analysts said.

"It had to do with European weakness. Its stock market got hit hard and the UK had some bad economic news." said Brian Edmonds, head of rates trading at Cantor Fitzergald in New York.

European shares tumbled to their lowest close since mid-2003 with the FTSEurofirst 200 index of top European shares ending down about 5 percent. On the other side of the Atlantic, the Standard & Poor's 500 index was off 4 percent.

Still, the two-week or so trend of falling interbank rates remained intact. "We have taken great steps this week to a new normalcy," Edmonds said.

Friday's improvement followed two weeks of dramatic drops in interbank lending rates after governments committed trillions of dollars in guarantees and capital to banks to prevent a collapse in credit markets. Three-month dollar rates have dropped more than one and a quarter percentage points in that time.

More government help is on the way when the U.S. Federal Reserve will launch its commercial paper purchasing program on Monday, providing further relief to that struggling sector.

DEEP RATE CUTS EYED

Investors' view on the world economy darkened, slamming stocks and sparking a surge to multiyear highs for the dollar and the yen. The first contraction in the UK economy in 16 years in the third quarter added to the growing evidence of an unexpectedly sharp slowdown in the global economy.

Some analysts said those worries have exacerbated credit crisis-induced anxiety and have kept borrowing rates high.

Financial markets expect central banks around the world to slash rates, following a coordinated 50 basis point cut by a group of major central banks earlier in the month to boost market sentiment.

Traders are betting the Fed will slash its target rate by 75 basis points to 1.0 percent next week to help avert a deep, prolonged U.S. recession.

The market is also pricing in at least a 50 basis point rate cut by the Bank of England in November and a cumulative 75 basis points of cuts from the European Central Bank by the end of the year.

Traders said Libor rates were unlikely to continue to drop sharply because the flow of longer-dated funds in the market remains hesitant at best.

"Central banks are pressing banks to start lending, and that is helping the front end ... but it doesn't surprise me that banks are still cautious further out." said Kenneth Broux, financial market economist at Lloyd's TSB in London.

In Asia, the Bank of Japan offered to loan 600 billion yen ($6.35 billion) against pooled collateral in an auction, extending a streak of fund injections into the banking system, while Australia's guarantee on local-bank deposits threw the nation's saving industry into crisis resulting in around $8.6 billion funds being frozen.

(Additional reporting by Naomi Tajitsu in London; Editing by Tom Hals)