Global rate cuts cool only overnight lending cost

LONDON/NEW YORK (Reuters) - Overnight lending rates between banks fell on Wednesday after emergency coordinated interest rate cuts around the world, but the cost of borrowing longer term stayed stubbornly high.

The interbank cost of overnight borrowing in dollars, euro and sterling fell toward central banks' new target rates of 1.5 percent, 3.75 percent and 4.5 percent, respectively.

By late trading, the overnight rate on dollar deposits fell to 1.50 percent, a far cry from the earlier 7.50 percent, which signaled the continued distress in credit markets.

Monetary authorities in the United States, euro zone and Britain each slashed benchmark rates by half a percentage point, as did the Canadian and Swedish central banks, while China and Switzerland also cut rates.

The joint action to calm panicky markets followed the announcement of sweeping measures from Britain to support its banks, including a capital injection of up to 50 billion pounds.

The rate cuts came after the British Bankers Association's daily fixing of London interbank offered rates (Libor), which had shown a fall in overnight euro and sterling rates, but a sharp jump in overnight dollars.

Following the rate cuts, the U.S. Treasury sold $20 billion in prior government debt issues due to the intense safe-haven demand for them during the current financial crisis.

More Treasury supply can help boost activity in the repo market, a source of short-term cash for banks.

TERM FUNDING STILL TIGHT

Three-month borrowing rates, or "term" funding, were stuck at lofty levels in dollar, euro and sterling at the Libor fix, reflecting the continued reluctance of banks to lend.

Analysts said it will take time for the rate cuts and the array of central bank liquidity measures to lower term Libor.

But the immediate impact of the coordinated rate cuts and extensive central bank liquidity injections into money markets should put a cap on rates.

"It may take days or weeks for (dollar) Libor to come close to fed funds," said Alex Roever, short-term interest rate strategist at J.P. Morgan Securities in New York.

Interbank deposit rates are merely indicative prices and not necessarily the rates at which banks actually lend to each other. The once-a-day Libor fix is also an indicative rate, but it is a global reference point for trillions of dollars of contracts for financial, corporate and household borrowing.

ENOUGH?

The spreads of Libor over anticipated policy rates measured by average Overnight Index Swaps widened, as investors priced in further broad-based policy easing in the coming months.

Before the coordinated rate cuts, the rate differences between overnight dollar, euro and sterling deposits and their respective Overnight Index Swaps were the highest in several years.

Some analysts said Wednesday's joint monetary policy response might mark a turning point.

"We expect that financial spreads have peaked and the worst phase of the financial crisis is coming to an end," said Lena Komileva, G7 strategist at Tullet Prebon.

"A recession will stand in the way of a strong risk rally. But a depression looks increasingly unlikely and this month should mark the low point of the risk cycle."

Earlier, the European Central Bank's auction of $70 billion in one-day dollar funds was oversubscribed almost twofold.

Alongside the UK government's bank action, the Bank of England said it was expanding and extending its Special Liquidity Scheme to offer at least 200 billion pounds of liquidity to financial institutions against a broader range of collateral.

"There is no doubting that this is big. We are very impressed by the scale of this," said David Keeble, head of rates strategy at Calyon.

(Editing by Mike Peacock and Jan Paschal)