Fed funds effective rate drops below Fed's target range on December 31

(Reuters) - The U.S. interest rate that banks charge each other to borrow excess reserves averaged 0.20 percent on Dec. 31, marking the first time it has settled below the lower bound of the Federal Reserve’s target range since policy makers raised interest rates two weeks earlier.

The rate drop likely stemmed from a flood of cash into the banking system at year-end when investors typically prefer to hold more cash before redeploying it in the new year.

The year-end rush into cash and cash equivalents led on Thursday to a record amount awarded in the Fed’s reverse repurchase agreements, worth $474.59 billion at an interest rate of 0.25 percent to 109 bidders.

The fed funds effective rate, which the Fed targets to achieve its rate objective, had averaged 0.35 percent on Dec. 30, and had settled between 0.35 percent and 0.37 percent each day since the Fed on Dec. 16 announced an increase to its target range. The new target range is 0.25 percent to 0.50 percent, up from 0.0 percent to 0.25 percent, where it had been since December 2008.

The effective rate on Dec. 31 traded in a range of 0.08 percent to 0.63 percent amid the end-of-year rush for overnight funding, compared with 0.28 percent to 0.63 percent the day before.

Following a three-day New Year weekend, the fed funds rate was last quoted at 0.35-0.37 percent in early Monday trading, according to ICAP.

Reporting By Dan Burns and Richard Leong; Editing by Chizu Nomiyama