* Dollar Libor falls; 3-mth Libor/OIS spread below 300 bps
* 2-yr dollar swap spread falls to lowest in a month
* C.banks gain traction as banks lend cash, hoard less
(Recasts, adds quotes, comment, Libor fixings)
By Jamie McGeever
LONDON, Oct 20 (Reuters) - The interbank cost of borrowing dollars fell sharply on Monday as banks grew more confident of lending rather than hoarding cash, an indication the global money market freeze continues to thaw out.
London interbank offered rates for overnight dollars fell to a four-year low near the Federal Reserve’s target rate of 1.5 percent, one-week and three-month rates fell by almost half a percentage point and closely-watched three-month spreads back below 300 basis points.
At the height of the crisis earlier this months the spread was around 370 basis points.
In another sign central bank and government efforts over the last 10 days to get paralyzed money markets functioning again are succeeding, two-year dollar interest rate swap spreads fell to their lowest in a month.
Market participants on Monday pointed to dealers’ reports from Friday that one large U.S. bank had lent up to $20 billion in one-month dollar funds, pushing one-month interbank rates below 4 percent from around 5 percent.
“It started on Friday with one large U.S. bank offering cash, and that brought down cash rates,” said Francis Yared, strategist at Deutsche Bank in London.
“Policymakers are going to do everything they possibly can,” to get liquidity flowing through money markets and hopefully out to business, corporates and households, he added.
The Wall Street Journal reported late on Friday that JP Morgan (JPM.N) led three U.S. banks pumping dollars into the system for European counterparts to access.
“They fall in to the category (very small) of quality banks where everyone has put their cash,” said the head of rates trading at one bank, referring to JP Morgan.
A fall in dollar interbank rates is critical to getting gummed up global money markets functioning again.
A particularly acute shortage of dollars in European and Asian trading hours since the collapse of Lehman Brothers in mid-September exacerbated the global credit crunch as banks hoarded dollars to bolster their own balance sheets rather than take the risk of lending it out.
But government and central bank efforts, including huge injections of public funds into banks, cross-border currency swap lines and relaxation of collateral rules have eased some of the tight liquidity conditions caused by the credit crisis.
Overnight dollar Libor was fixed lower at 1.51250 percent USDONMFSR= versus 1.66875 percent on Friday, and one-week and three-month dollar Libor both around 43 basis points down at 2.71875 percent USDSWMFSR= and 3.75125 percent USD3MFSR=, respectively.
The spread of three-month Libor over anticipated policy rates as measured by Overnight Index Swaps — known as the Libor/OIS spread and considered a key gauge of financial market stress — fell to 294 basis points from around 331 basis points.
All sterling and euro Libor fell on Monday too, with the exception of overnight sterling rates. Sterling and euro Libor/OIS spreads widened a little though.
For all Monday’s Libor fixings from the British Bankers’ Association, see [ID:nLK288525].
Governments around the world have pledged about $3.3 trillion — about equal to the economic output of Germany — aimed at boosting interbank lending and shoring up their economies amid the global credit crisis.
South Korea was the latest government to join the global drive to support the banking system, unveiling a package worth over $130 billion of state guarantees on foreign debt and a promise to recapitalise financial firms if necessary. See [ID:nSEO366228].
The Bank of England on Monday acted to make it easier for commercial banks to get short-term funding, implementing new measures announced last week to free up UK money markets. For more, see [ID:nLK227951].
“Based on strong dollar term flows, the BoE money market reform and the ECB’s (European Central Bank’s) easing of lending conditions last week, we expect more rapid declines in Libor rates over the coming days,” said Lena Komileva, head of G7 strategy at Tullet Prebon.
“In contrast to earlier weeks, increased interbank liquidity means the declines in Libor are more than just a symbolic feature of an improved risk environment,” she said.
ECB Governing Council member Erkki Liikanen said on Monday financial market conditions are better now than they were a week ago.
In further signs interbank strains are easing, two-year dollar swap spreads narrowed on Monday to a one-month low of 106 basis points USDSB3L2Y=RR USD2YT=RR from around 116 basis points late in New York on Friday. Two-year euro swap spreads fell to as low as 101 basis points EURAB6E2Y= EU2YT=RR from around 108 basis points on Friday, the lowest in two weeks.
Swaps spreads measure the difference between the cost to exchange fixed for floating rate interest payments in the swaps market, and government borrowing costs over the same time frame. Narrowing spreads are generally considered a sign of improving financial market conditions.
But Deutsche Bank’s Yared cautioned against putting too much faith in what Libor is indicating with regard to actual activity in money and credit markets behind the screen-based prices.
He said developments like increased commercial paper market activity and money market funds extending the duration of their funding are better gauges of easing money market strains.
Libor rates are only indicative prices of where banks are lending to each other, not necessarily the levels at which lending is actually being carried out.