WRAPUP 4-Govts step up credit fight, US CP market shrinks

* Most Libor falls again, but spreads widen

* Central bank measures gain traction at short end

* U.S. commercial paper sector shrinks 5th straight week (Adds U.S. CP data, changes dateline, previous LONDON)

By Jamie McGeever and Richard Leong

LONDON, Oct 16 (Reuters) - Most bank-to-bank loan rates fell on Thursday in the wake of more drastic steps by central banks to provide funds, improve bank balance sheets and open up credit lines to cash-strapped institutions.

In the United States, data showed the critical commercial paper market contracted for a fifth straight week, as the Federal Reserve gears up a purchase program to fortify this struggling sector.

London interbank offered rates (Libor) for dollars, euros and sterling fell across all maturities, with the exception of overnight euro Libor, the British Bankers' Association's latest daily fixing showed.

Sizable declines were noted in dollar and sterling Libor at the short end from overnight to two weeks. And even though overnight euro Libor edged up, it was fixed right on the European Central Bank's target rate of 3.75 percent.

But the Libor fixings weren't uniformly encouraging. The Libor premium over anticipated policy rates -- a key measure of financial market dislocation -- rose as deepening fears of recession strengthened expectations central banks will have to slash interest rates.

"The cost of funding is still enormous and prohibitive to create credit," said Rudy Narvas, senior strategist at 4Cast Ltd. in New York.

CREDIT FIGHT ABROAD

Still, the falls in nominal Libor, a global rate benchmark for an estimated $360 trillion of loans, came a day after the ECB said it will allow banks to swap a larger range of assets for central bank funds across a range of currencies, effectively opening up the liquidity taps as far as it can.

The Bank of England said on Thursday it will launch a discount window facility next week, making more cash available to banks, while the Swiss National Bank will create a vehicle for troubled assets as part of a sweeping rescue plan for banks UBS (UBSN.VX) and Credit Suisse (CSGN.VX).

For more on the ECB's, SNB's and BoE's latest moves, see [ID:nLF183746], [ID:nLG661475] [ID:nBOE001590].

In Asia, the Bank of Japan injected some 600 billion yen ($6 billion) in same-day funds into the banking system, returning to the market after skipping its cash injecting operation for the first time in almost a month on Wednesday.

Analysts said the ECB's measures in particular were extraordinary and should help unclog the arteries of the interbank market. See [ID:nLF183746].

Overnight dollar Libor was fixed more than 20 basis points lower at 1.93750 percent USDONFSR= and overnight sterling Libor fell 20 basis points to 5.17000 percent GBPONFSR=

Euro Libor fell more steeply further out the curve, with three-month rates falling almost 10 basis points -- its biggest decline this year -- to 5.08125 percent EUR3MFSR=.

For more on Thursday's Libor fixings, see [ID:nLG699934].

But the retreat in Libor is seen as glacial, frustrating some traders and surprising some bank executives.

Citigroup (C.N) Chief Financial Officer Gary Crittenden said on Thursday he was "puzzled" that the recent fall in Libor has been so modest, but added it will take time for financial industry changes to take place. See [ID:nWEN9189]

COMMERCIAL PAPER SHRINKS

The U.S. commercial paper continued to contract despite signs of limited recovery less than two weeks before the Fed's implementation of a commercial paper purchase program.

For the week ended Wednesday, the size of the U.S. commercial paper market, a critical source of funds for many companies in financing their daily operations, fell $40.3 billion to $1.511 trillion, the Fed said.

That brings the cumulative decline of this market to $304 billion over a five-week span, including the previous week's $56.4 billion drop. For more, see [ID:nN16379926]

"Buyers and sellers are going to sit on the sidelines until the Fed starts its CP program," said 4Cast's Narvas.

The Fed plans to launch its Commercial Paper Funding Facility under which it will buy top-rated 3-month commercial paper on Oct 27.