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TOKYO, Sept 30 (Reuters) - Central banks and regulators scrambled on Tuesday to relieve the strain on financial markets frazzled by another hefty blow to confidence, this time from the rejection by U.S. lawmakers of a $700 billion rescue plan.

Global central banks more than doubled the amount of dollar funding to $620 billion, but the move showed no signs on Tuesday of thawing the freeze in money markets where banks are hoarding cash and bracing for more trouble ahead in the deepening year-long credit crisis.

Analysts said central banks may now be forced to cut interest rates in a coordinated move because their massive fund injections have done little to ease strains that are threatening to become a bigger systemic breakdown that could endanger the global economy.

After the U.S. House of Representatives rejected the bailout for the U.S. financial system, Wall Street shares suffered their biggest sell-off since the 1987 crash. Asian shares were battered as well, falling 3-5 percent.

"The case for large synchronised global rate cuts is stronger than ever before," said Rory Robertson, interest rate strategist at Macquarie in Sydney.

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.

"What's important is that all people of good will around the world act in concert with our friends in the United States to see the right measures taken through the U.S. political process to stabilise the global financial system," he told a press conference.

CENTRAL BANKS STRUGGLE

The Bank of Japan injected 3 trillion yen ($28.3 billion) of same-day funds in the latest effort to ease the stress in yen money markets as Japanese banks have balked at lending to foreign institutions before closing their books on the first half of the business year on Tuesday.

The BOJ's injection matched a one-day record for the biggest such operation since the central bank scrapped its quantitative easing policy of flooding banks with cash in 2006.

The Reserve Bank of Australia pumped extra cash into the market via a A$1.95 billion operation, adding to the banks' cushion that was already at record levels.

In an effort to bolster equity markets, South Korea's financial regulator banned short-selling of stocks and Taiwan said it would place tighter limits on short-selling.

Hong Kong said it was ready to take aggressive measures against short sellers, a trade in which investors aim to profit from a fall in a share price.

Investors have been spooked by the inability of policy makers to prod banks to increase lending even though they are making hefty provisions of short-term funds.

In what some analysts have called Black September, the bankruptcy of Lehman Brothers, the nationalisation of insurance giant AIG and demise of big banks like Washington Mutual have shattered institutions' confidence in dealing with each other.

The strains have had a ripple affect in the commercial paper markets used by companies for short-term cash needs that threatens to cause a broader hit to economic activity.

Banks have had a hard time coming up with the dollars they need to fund their positions and operations, leading to a rush for dollars wherever institutions can find them.

The end of the third-quarter on Tuesday has also prompted banks to shy away from lending, exacerbating the squeeze.

AWASH IN CASH

The Federal Reserve more than doubled reciprocal swap lines with the European Central Bank and eight other central banks on Monday to $620 billion from $290 billion previously.

The actions by the central banks have left banks with more than they need. But many are still clinging to the funds.

"No one wants to lend at the moment because there's too much fear," said a senior money market trader at a European investment bank in Singapore. "Most banks are keeping a nice cash buffer for themselves at the moment."

In Japan, the overnight call rate -- the BOJ's policy target -- traded 10 basis points below the current target at 0.4 percent because domestic banks are awash in extra funds.

But as foreign banks had trouble securing cash in the yen market, the rate paid BOJ's one-day operation in the morning was 0.75 percent.

In the United States, the federal funds rate fell to 1 percent -- half the level of the Fed's current 2 percent target and a reflection of the excess funds in the banking system.

Yet showing how deep the stress runs in the dollar funding market, three-month dollar LIBOR was set the previous day at 3.88 percent -- an usually big 2.30 percentage points above the expected fed funds rate in three months time.

Traders said overnight dollar funding rates soared as high as 8 percent in Asia.

Until the collapse of Lehman, that spread had never been much more than 1 percentage point. Before the crisis struck last August, it had usually been less than 0.01 percentage point.

Kansas City Fed President Thomas Hoenig said that while he detected a definite sense that the sky is falling, "we will work through this" and the economy is resilient.

($1=103.98 Yen)

(Additional reporting by Chikako Mogi in Tokyo, Michael Perry and Wayne Cole in Sydney, Ros Krasny in Nebraska)

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nt

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