LONDON/NEW YORK (Reuters) - The cost of borrowing overnight dollars skyrocketed on Tuesday, prompting central banks worldwide to unleash billions into money markets to prevent them from a lockup, a day after U.S. lawmakers’ rejection of a $700 billion financial industry bailout.
A flood of money from central banks seemed successful in meeting banks’ quarter-end scramble for cash. It helped to drive the overnight lending rate between U.S. banks close to zero percent from its multi-year high.
“Money markets are more of a problem than stock markets. Perceived counterparty credit risk ... probably won’t go away for a while,” said Everett Brown, strategist at IDEAGlobal.
The hoarding of cash was especially aggressive in the euro zone, where a handful of banks have been rescued by governments since Monday due to rising losses stemming from the credit crisis.
Cash was also in demand among investors to settle trades whose values swung wildly over the past several months.
The London interbank offered rate (Libor) for overnight dollars jumped by a record 430 basis points to 6.87 percent, the highest in at least 7-1/2 years.
Reflecting the scarcity of funds in the interbank market, banks also borrowed 15.481 billion euros overnight from the ECB, the largest amount in almost six years.
In response to this intense quarter-end demand for dollar funds, the European Central Bank lent $60 billion overnight in two separate operations.
It initially loaned $30 billion dollars at a whopping rate of 11 percent -- more than five times the Federal Reserve’s 2 percent target rates, followed by another $30 billion in a subsequent auction.
In addition to its dollar efforts, the ECB was pouring in 190 billion of euros via its regular weekly auction but tensions were high there too.
Banks bid up to 5.5 percent, and the weighted average rate of 4.96 percent was the highest on record for a main refinancing auction.
Across the Atlantic, the Federal Reserve conducted a $20 billion in 28-day repurchase agreements.
For their part, the central banks of Japan, Australia and Britain injected liquidity into their respective banking systems on Tuesday to help banks meet funding obligations over the coming days, weeks and months.
The surge in overnight and term funds due to efforts from central banks pulled some money rates from their early highs.
For example, the benchmark U.S. federal funds rate steadily fell to 0.50 percent by midday in New York after opening at 7 percent four hours earlier.
After the U.S. House of Representatives late on Monday rejected the $700 billion rescue package and sent share prices plunging, fears of further meltdown in Europe grew.
But a collapse of European equities failed to materialize, with prices in part buoyed by the Irish government’s decision to guarantee all bank deposits and speculation central banks could cut interest rates in concert soon.
Australia, Britain and Europe are working to convince U.S. lawmakers to pass the $700 billion rescue package, which would allow the U.S. Treasury to buy up bad debt from banks, Australia’s prime minister Kevin Rudd said on Tuesday.
The growing calls for closer cooperation are extending to potential coordinated interest rate cuts from the Fed and European central banks, even though they’d only do so as a last resort to boost confidence in financial markets, analysts say.
But a strong rebound in U.S. and European equities a day after their dramatic plunge curbed expectations of imminent rate cuts.
Interest rate futures markets were pricing less a one-in-three chance the Fed will cut rates by 50 basis points to 1.5 percent by or at its October 29 policy meeting. Earlier, they had priced in a two-in-three chance of such a move.
Markets still fully expect the ECB to cut a quarter point to 4 percent by the end of the year and to 3.75 percent by February.
Writing by Richard Leong, Additional reporting by Chikako Mogi in Tokyo, Michael Perry and Wayne Cole in Sydney and Ros Krasny in Nebraska, Editing by Chizu Nomiyama