May 3, 2019 / 6:43 PM / in 18 days

MONEY MARKETS-U.S. fed funds rate slips after Fed's tweak on reserves

* Fed funds rate falls to lowest since mid-April

* Fed funds/IOER, however, hit a record 6 bps on Thursday

* Repo facility seen best to control fed funds rate - BAML (Adds background, quotes, graphic)

By Richard Leong

NEW YORK, May 3 (Reuters) - The rate U.S. banks charge each other to borrow reserves overnight fell on Thursday a day after the Federal Reserve adjusted what it pays banks on reserves they leave with the U.S. central bank, New York Federal Reserve data released on Friday showed.

The average or effective federal funds rate fell to 2.41%, the lowest since April 16, from 2.45% on Wednesday.

The fed funds rate’s premium above the Fed’s interest on excess reserves (IOER), however, grew to a record-high 6 basis points from 5 basis points the day before.

A number of factors have led to the stubborn upward drift in the fed funds rate, including reduced bank reserves linked to the Fed’s balance sheet normalization, increased government borrowing, and less willingness by big banks to lend reserves due to tougher capital standards in response to the global credit crisis.

On Wednesday, the Fed shrank the gap between the IOER and the bottom end of its target rate on interest rates for a third time since last June in a bid to prevent the fed funds rate reaching the top of the range.

It trimmed IOER by 5 basis points to 2.35%, while holding its target range at 2.25-2.50%.

“The Fed got its intended results,” said John Bellows, portfolio manager at Western Asset Management Co. in Pasadena, California. “The IOER cuts are technical in nature.”

Still the Fed’s control of the fed funds rate is critical to bolster investors’ confidence in its effectiveness to conduct monetary policy.

Bank of America Merrill Lynch strategists Mark Cabana and Olivia Lima said on Friday the latest IOER move “is only a Band-Aid” to keep a lid on upward pressure on the fed funds rate.

They suggested the central bank should introduce a standing repo program that would allow banks to exchange their Treasury holdings for short-term cash as the best means to control the fed funds rate.

Reporting by Richard Leong Editing by Chizu Nomiyama and James Dalgleish

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