Bank earnings hold pre-Christmas key

LONDON (Reuters) - Defusing the interbank lending tensions at the heart of the global credit crisis will depend this week as much on a series of key year-end bank earnings as on last Wednesday's concerted central bank rescue.

As euphoria fades over central banks' initiative to provide banks with penalty-free cash where necessary over the coming months, the fear of heavy credit losses and balance sheet hits keep banks wary of lending to each other.

Fourth-quarter results from Goldman Sachs (GS.N) and Bear Stearns BSC.N will be monitored closely by all financial markets for further insight into the extent of balance sheet damage.

Financial firms have to date written down more than $65 billion in credit-related losses. With official estimates of total losses from the subprime mortgage debacle around $300 billion, investors are braced for further shocks.

While the epicenter of the crisis lies U.S. subprime mortgages, the aftershocks have been affecting the world's major investment banks which repackaged these risky mortgages and sold them to yield-hungry investors.

"It's still probably a little bit early to come back into banks just because the visibility we have on different balance sheets is still relatively low," said Thierry Lacraz, strategist at Pictet & Cie.

"I would wait for detailed results for the quarter for the banks before entering into the sector again."

European banking stocks, as measured by the banking sector index .SX7P, are down more than 18 percent since January.

NO SILVER BULLET

Stocks and other risky assets including high-yielding currencies failed to extend the rally made after central banks in the United States, Britain, the euro zone, Canada and Switzerland announced a liquidity rescue package on Wednesday.

The five central banks are starting their new liquidity measures this week, with the Fed offering $20 billion through its Term Auction Facility program.

While the rates at which banks charge to lend to each other eased slightly after the launch of the rescue package, banks are still charging a high premium on cash as they themselves need liquidity to shore up balance sheets before the year end.

Interbank lending rates for one-month and three-month funds in the dollar, euro and sterling LIBOR fell again on Friday.

However, the premium banks charge on lending to each other over borrowing from the government remained unusually high, reflecting lingering tensions in the market.

"The concerted action was a good step in the right direction, but it's not a silver bullet either. We will see in the next few weeks how it develops. Banks are still under pressure and that's not going to go away," said Laurent Fransolet, head of fixed income strategy at Barclays Capital.

Developments in money markets and in U.S. housing data due this week should set the tone for investor risk appetite by offering more evidence of the scale of the credit squeeze.

STAGFLATION CONCERN

After hitting a one-week high the MSCI main world equity index .MIWD00000PUS has finished the week slightly lower than the previous week. Still, it trades comfortably above the August trough, hit just after the credit crunch started.

Analysts say declines in leading indicators in major economies point to economic weakness spreading beyond the United States, challenging the popular "decoupling" theory.

The closely watched German Ifo corporate sentiment survey due this week, where the headline index is seen falling in December, could show the credit crunch is taking a toll on sentiment beyond the financial sector.

And this week's consumer inflation data from Britain and Canada could add to further evidence that the global economy is facing inflationary pressures and limiting central banks' scope to respond to the credit crisis.

Higher inflation figures could help gold -- considered an inflation hedge -- to launch a fresh assault on a 28-year high set in November.