Global credit fix hits bump, CP market shrinks

By Kirsten Donovan and Richard Leong

LONDON/NEW YORK (Reuters) - Efforts to unlock global money markets hit a snag on Thursday as banks raised their lending rates on dollar funds for the first time in two weeks.

Outside of the interbank lending, the U.S. commercial paper market -- despite evidence of improved demand for this type of corporate debt -- contracted for a sixth straight week to its smallest in 3-1/2 years. Commercial paper allows many U.S. companies to fund their day-to-day operations

"Things have stabilized a bit, but it's still spotty," said Jeff Given, portfolio manager at MFC Global Investment Management in Boston.

In the last two weeks, bank-to-bank lending costs have fallen sharply after huge cash injections, bank bailouts and interest rate cuts by central banks and governments worldwide. For example, 3-month dollar rates are down nearly 1-1/4 percentage points.

Analysts fear the relief could be negated by a sharp global slowdown, which could tighten bank lending to companies.

Bank of Canada Governor Mark Carney said on Thursday he expects the United States will dip into a recession while other major economies continue to slow.

This grim assessment, together with the rise in dollar funding rates, reined in optimism that the worst of the financial crisis has passed, analysts said.

"You have to ask yourself how much lower we can go given everything we currently see, especially with the expectations embedded in the forward rates," said Dresdner Kleinwort rate strategist Christoph Rieger in Frankfurt.

CP MARKET DEFLATES

The U.S. commercial paper market continued to deflate despite falling rates and improved investor appetite.

U.S. Federal Reserve data showed outstanding CP fell $61.4 billion in the week ended Oct 22 to $1.449 trillion, a level not seen since 2004.

But help may be on the way for the commercial paper market as the Fed will launch its purchase program of high-quality, 3-month CP on Monday.

"There is an end in sight. A significant (remedy) will come into play on Monday when issuers have ability to effectively sell paper to the Fed," said Stephen Wesselkamper, a money market portfolio manager at Cleveland-based Victory Capital Management, which invests about $59 billion.

IMPROVING TREND INTACT

While the uptick in dollar lending rates raised some eyebrows, the trend of improving credit conditions remained intact, analysts and investors said.