MONEY MARKETS-Central banks keep lending markets afloat

By Pedro Nicolaci da Costa

NEW YORK, Dec 4 (Reuters) - Central banks remained the primary source of capital for the global economy, with Europeans cutting interest rates sharply on Thursday and the Federal Reserve acting as commercial lender of last resort.

The European Central Bank, Bank of England, Sweden's Riksbank and Bank of New Zealand all cut benchmark interest rates by between 0.75 and 1.75 percentage points to help veer the global economy away from a prolonged downturn. See [ID:nHKG108699]

The U.S. central bank, for its part, was expected to follow suit later in the month, bringing rates to their lowest level in more than 50 years.

In the meantime, the Fed has stepped up its efforts to support the U.S. commercial paper market, providing short-term funding for firms, in an effort to revive private bank lending.

U.S. commercial paper outstanding rose for a sixth straight week to $1.652 trillion, up $11.5 billion in the last seven days. The asset-backed commercial paper segment, which had helped to fuel the housing boom that went bust, fell $15.1 billion on the week.

There were also few signs that the Fed's own efforts were reviving private lending. Instead, it looked like the Fed was merely replacing the private sector, fulfilling its role as lender of last resort.

"When one nets out what the Fed has bought and compares it to the total increase in the size of the commercial paper market, one concludes that traditional buyers have moved to the sidelines," said Tony Crescenzi, chief bond market strategist at Miller Tabak.

Interbank borrowing rates did react to the concerted easings by European monetary authorities. The rates banks charge each other for borrowing dollar, euro and sterling funds edged lower.

But persistent anxiety over the global financial crisis, exacerbated by year-end funding pressures, has kept the spread of three-month London interbank offered rates (Libor) over anticipated central bank rates, or Overnight Index Swap (OIS) rates, at elevated levels.

The three-month dollar/OIS spread expanded 6 basis points to 189 basis points, signaling a lingering nervousness among investors.

"We're still a long way from normalization and a long way from levels where banks will be prepared to lend again," said Nick Stamenkovic, bond strategist at RIA Capital Markets in Edinburgh.

Indeed, banks continued to prefer hoarding the cash given to them by central banks rather than lend it out.

Latest data showed European banks deposited 231.6 billion euros at the ECB overnight as of Dec. 3, up from 217.4 billion euros reported on Wednesday, but still below the record 297.4 billion euros seen early last month.

Meanwhile, the Fed's balance sheet continued to expand, suggesting it continues to take on the bad debts of banks in the hope that they will begin lending again.

With borrowing grinding to a halt and firms having trouble raising money, economic activity has slowed sharply.

Economists are now looking for a 3.0 percent decline in annualized fourth quarter U.S. gross domestic product, the worst performance in nearly two decades.

Earlier this week, a panel of economists formally declared the U.S. economy in recession since December 2007, while markets are also dealing with slumping prices and the threat of deflation in Japan and elsewhere.

There were also signs that the crisis, which began with rising defaults on mortgages, could expand to the commercial real estate sector. JPMorgan Chase & Co (JPM.N) seized tens of millions of dollars of collateral from a commercial property debt fund run by Guggenheim Partners LLC, the Wall Street Journal reported on Thursday.

(Additional reporting by Ellen Freilich and Ian Chua)

Reporting by Pedro Nicolaci da Costa)