Money markets stay locked; o/n rate soars

By Jamie McGeever and Kirsten Donovan

LONDON (Reuters) - The cost of borrowing overnight dollars on global money markets soared on Tuesday despite central banks pumping billions into the banking system to prevent it seizing up further after U.S. lawmakers' rejection of a S700 billion financial rescue bill panicked markets.

The scramble for cash as banks sought to square their books over the end of the quarter saw the European Central Bank lend $30 billion dollars overnight at a huge rate of 11 percent -- more than five times the Federal Reserve's 2 percent target rate -- and call for bids for an additional $50 billion.

Meanwhile, the London interbank offered rate (Libor) for overnight dollars jumped by a record 430 basis points to 6.87 percent, the highest in at least 7-1/2 years.

After the U.S. House of Representatives late on Monday rejected the $700 billion rescue package and sent Wall Street shares plunging, fears of further meltdown in Europe grew.

But in part buoyed by the Irish government's decision to guarantee all bank deposits and speculation central banks could cut interest rates in concert soon, a collapse of European equities failed to materialize.

European shares erased initial losses to trade largely flat on the day .FTEU3 .FTSE and U.S. stock futures pointed to a higher opening on Wall Street.

"Money markets are more of a problem than stock markets. Perceived counterparty credit risk ... probably won't go away for a while," said Everett Brown, strategist at IDEAGlobal.

He said interbank rates and premia over government borrowing costs and expected policy rates -- key gauges of financial market stress and investor risk aversion -- should come down from historically high levels in the coming sessions.

"They will come down a bit over coming days and weeks due to the U.S. package (probably) getting passed, more of these central bank liquidity operations going through, and the end of the quarter out of the way," he said.

The central banks of Japan, Australia, Britain and the euro zone injected liquidity into their respective banking systems on Tuesday to help banks meet funding obligations over the coming days, weeks and months.

A stark measure of banks' reluctance to lend to one another was their placing a record amount of overnight deposits at the European Central Bank on Monday worth 44.353 billion euros.

Reflecting the scarcity of funds in the interbank market, banks also borrowed 15.481 billion euros overnight from the ECB, the highest in almost six years.

"The financial system is self-destructing as we watch it, it's feeding off itself and it's hard to know what will stop it or what the financial infrastructure will look like when it's over," said Nomura rate strategist Sean Maloney.

COORDINATED RATE CUTS?

The Libor interbank cost of borrowing dollars for three months was almost a fifth of a point higher at 4.05 percent on Tuesday, with the premium paid over anticipated central bank rates (or Overnight Index Swap rates) widening to a record 247 basis points from around 219 on Monday.