Bank lending still hobbled as Congress deliberates

NEW YORK/LONDON (Reuters) - Interbank lending remained at a standstill worldwide on Friday as investors nervously awaited a U.S. House of Representatives vote on a $700 billion financial rescue package.

Key benchmark rates for the banking industry extended their upward march. Three-month dollar Libor rates climbed to 4.33375 percent, the highest since early January, while their 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.

Adding to the anxiety was fear over the outcome of the House of Representatives' vote on a bailout package aimed at shoring up the banking sector, whose travails seemed to be spilling over into the real economy.

The U.S. labor market, for instance, posted its worst performance in over five years in September, with 159,000 jobs wiped out.

The pace of deterioration in the economy was so rapid that faith in the rescue plan was waning.

"Events are moving awfully fast relative to policy," said Neal Soss, chief economist at Credit Suisse. "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 premium to borrow at Libor over anticipated policy rates, as measured by average Overnight Index Swap rates, blew out further to around 290 basis points, another 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, 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 monetary authorities in Asia in providing financial institutions with 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 act. 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 this to be brief, and potentially short on specifics.

LENDERS OF FIRST RESORT

In the meantime, central banks had little choice but to act aggressively to stem the seizure in global credit. The Bank of Japan (BOJ) 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.

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 so-called 'fine-tuning' operations for overnight auctions.

The ECB also said on Friday financial institutions upped their borrowing from and deposited another hefty amount at the central bank.

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

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

Regarding the United States, many now expect the Fed will begin cutting rates again after a five month hiatus, probably with an aggressive half percentage point ease at its meeting later this month.

In the United States, there was no relief for the commercial paper market. Outstanding paper slumped by $94.9 billion to $1.607 trillion, Federal Reserve 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 per day 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 Chizu Nomiyama)