October 13, 2008 / 9:44 AM / 10 years ago

UPDATE 2-Libor falls as rescue plans bolster confidence

(Adds Libor fixings, quotes, comment, background)

By Jamie McGeever

LONDON, Oct 13 (Reuters) - The interbank cost of borrowing in sterling, euros and dollars fell on Monday as confidence in money markets showed signs of returning as European governments took sweeping action to support the creaking banking system.

Three-month euro Libor posted its biggest decline this year and three-month dollar Libor had its steepest fall since March, the British Bankers Association’s daily fixing of London interbank offered rates (Libor) on Monday showed.

Libor, the global benchmark for corporate, financial and household borrowing, showed declines across the currency spectrum and most time horizons.

The Libor premium over anticipated official borrowing costs as measured by average Overnight Index Swap rates, a key test of financial market stress, also fell.

This suggests the wide range of bailouts, guarantees and liquidity injections that could potentially run into trillions of dollars might mark a turning point where frozen money markets begin to thaw and banks slowly start lending again.

“Lower Libor fixings finally start to reflect exceptional liquidity measures taken by global central banks. Accordingly, spreads are compressing from the top experienced just a couple of weeks ago,” BNP Paribas strategists said in a note on Monday.

“Governments and central banks are regaining control via further exceptional measures. Guaranteeing interbank lending is crucial to improve financial market conditions,” they added.

Three-month euro Libor fell to 5.29875 percent from 5.36625 percent EUR3MFSR= on Friday, the BBA’s fixing on Monday showed, the biggest one-day fall since Dec. 28 last year.

Three-month dollar Libor was fixed 6.625 basis points lower at 4.75250 percent USD3MFSR=, the biggest fall since March 17.

The three-month dollar, euro and sterling Libor/OIS spreads all narrowed, having hit historic highs last week.

For more on Monday’s Libor fixings, see [ID:nLD281678].

TIME

European governments have said they will buy stakes in banks and offer guarantees for bank-to-bank loans for a limited period in order to bring paralyzed money markets back to life.

Britain bailed out three major banks with a 37 billion pounds capital injection, part of a broader packages that includes bank loan guarantees, while Germany’s rescue package could be worth up to 500 billion euros.

European central banks also announced they will aggressively expand their provision of dollar liquidity to the region’s financial institutions to help them meet dollar funding needs. For more, see [ID:nLD182017].

Asian and European equity markets breathed huge sighs of relief on Monday from the action aimed at getting banks lending again and preventing the economic contagion from the financial turmoil turning into a more serious collapse.

But while Europe’s bold action will go a long way to preventing systemic meltdown of the world’s financial system, it will take longer for confidence to fully return to banks and therefore for lending to resume fully.

“By the end of the week there is a good chance now that money market rates will be sliding lower and interbank activity beginning to pick up a little,” according to ICAP.

“Crucially though, a meaningful recovery in interbank lending activity now depends on the speed with which European countries can implement the promised interbank lending guarantees.”

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.

Data from the European Central Bank on Monday showed just how reluctant banks have been to lend to counterparts. Euro zone financial institutions deposited a record 155 billion euros at the ECB overnight on Friday.

Still, analysts reckon Europe’s bold steps, which many said eclipsed the Group of Seven pledges of action and coordination, should successfully tackle the lending paralysis over time.

“It’s enough to get these money markets up and running again,” said David Keeble, head of rates strategy at Calyon in London.

“But it might take a few weeks to get it filtering through to the coal face, as it were,” he said. (Editing by Toby Chopra)

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