WRAPUP 5-Bank lending hobbled as bailout bill becomes law

* U.S. rescue package goes into law, but stocks still fall

* 3-month USD Libor highest since Jan, euro Libor a record

* Central banks inject billions more short-term liquidity

* Overnight dollar Libor below 2 percent Fed Funds target (Updates with signing of bailout law, market reaction)

By Pedro Nicolaci da Costa and Jamie McGeever

NEW YORK/LONDON, Oct 3 (Reuters) - Interbank lending remained jammed up around the world on Friday even as investors gave a lukewarm reception to the passage of an anxiously awaited $700 billion U.S. financial sector bailout package.

Key benchmark interest rates for the banking industry extended their upward march. Three-month dollar Libor rates USD3MFSR= climbed to 4.33375 percent, the highest since early January, while the euro-denominated equivalent surged to a record.

This credit freeze was forcing central banks to continue flooding the global banking system with cash in an effort to lubricate stalled capital markets, which were suffering from a heavy dose of mistrust between financial institutions.

Such efforts have thus far failed to quell fears of insolvency related to a swooning American mortgage market, prompting calls for broader action by U.S. and European governments.

U.S. President George W. Bush swiftly signed the bailout package into law but the stock market ended 1.5 percent lower, an indication of the deep-seated nature of troubles in the financial sector. To read more see [ID:nSP58422].

"Events are moving awfully fast relative to policy," said Neal Soss, chief economist at Credit Suisse in New York. "The economy is weakening significantly and there's more of that ahead because the credit strains of earlier in the year have only intensified."

The U.S. labor market posted its worst performance in over five years in September, with 159,000 jobs wiped out. The pace of deterioration was so rapid, in fact, that faith in the ability of the rescue plan to stem the damage was waning.

There were also lingering doubts about implementing the bailout. A Treasury official said on Friday the department will hire five to 10 asset management firms to help handle the purchase of illiquid assets under the plan Congress approved.

The official, who requested anonymity, also said Treasury will take on about two dozen full-time employees to develop a process to ensure no conflicts of interest occur. Sources familiar with the plan also said the first of many expected asset sales would not take place for at least four weeks.

Earlier, the premium to borrow at Libor over anticipated policy rates, measured by average Overnight Index Swap rates, blew out further to around 290 basis points, a historic high.

Very short-term borrowing costs benefited from an inordinate amount of liquidity from central banks. Overnight dollar Libor tumbled almost 70 basis points to 1.99625 percent USDONFSR=, beneath the Federal Reserve's overnight target of 2 percent and the lowest in almost four years.

The European Central Bank and Bank of England joined authorities in Asia in providing financial institutions a plentiful supply of short-term liquidity on Friday. The ECB and BoE also eased rules governing liquidity provisions.

These actions had not yet succeeded in alleviating all but very short-horizon transactions. Funding costs for loans of a month or longer remain expensive and scarce because banks prefer to hoard cash than lend to counterparties they fear may be in severe financial distress.

European governments were also under increasing pressure to take action. French President Nicholas Sarkozy is due to meet the leaders of Germany, Italy and Britain, as well as senior EU officials and European Central Bank President Jean-Claude Trichet on Saturday to try to find a common approach.

But many analysts expected the meeting to be brief and potentially short on specifics.

LENDERS OF FIRST RESORT

Meantime, central banks around the world had little choice but to act aggressively to stem the seizure in global credit. The Bank of Japan injected 800 billion yen ($7.6 billion) in an over-the-weekend operation and Australia's central bank added A$1.57 billion ($1.2 billion) in repurchase agreements, way above an estimated daily need of A$1.195 billion.

In Europe, the BoE auctioned $10 billion overnight money and $30 billion of one-week cash. It also relaxed collateral rules for its weekly three-month auctions. [ID:nL3313645]

The ECB auctioned $50 billion of three-day funds, having drawn bids of over $82 billion, and threw open the doors for thousands of banks to access its 'fine-tuning' operations for overnight auctions. See [ID:nL3242544].

The ECB also said on Friday financial institutions upped their borrowing from the central bank.

The ECB left its benchmark rate on hold at 4.25 percent on Thursday but highlighted the risk to the European economy from the credit crunch, suggesting the first euro zone rate cut in five years was on the cards.

Many now expect the Fed will begin cutting rates again after a five-month hiatus, probably with an aggressive half percentage point ease at a meeting scheduled for this month.

Financial markets now expect a rate cut at the ECB's next meeting and a further two cuts to 3.50 percent by February.

In the United States, there was no relief for the commercial paper market. Outstanding paper slumped by $94.9 billion to $1.607 trillion, Fed data showed, bringing the cumulative shrinkage to $208 billion in the past three weeks.

Fed data also showed banks borrowed a record $367.8 billion from the central bank in the latest week. (Additional reporting by Eric Burroughs and Yuzo Saeki in Tokyo, Kevin Yao in Singapore, Wayne Cole in Sydney and Alister Bull in Bloomington, Indiana; Editing by James Dalgleish)