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MONEY MARKETS-Dollar spreads stay stubbornly wide

Wed, Nov 26 2008, 13:31 GMT
http://www.afxnews.com

By Ian Chua

LONDON, Nov 26 (Reuters) - The bank-to-bank lending rates for dollar, euro and sterling funds mostly drifted lower on Wednesday as some central banks added liquidity into the system but signs of funding strains as the year-end looms were visible.

The premium paid for London interbank offered rates (Libor) over anticipated central bank policy rates or Overnight Index Swaps (OIS) stayed stubbornly wide for dollar and sterling.

On the whole, the improvement seen in the interbank money market following a slew of measures by major central banks and governments aimed at lubricating the banking system has stalled in recent weeks.

"Part of it, we think, has to do with the approach of year-end ... not the best time in any year to try to get banks to expand their balance sheets, let alone this year. Another obstacle is that the cost of bank balance sheet remains high," said Morgan Stanley's analyst Laurence Mutkin.

In any given year, banks tend to hoard cash and simply don't lend to each other ahead of the end of the year as part of measures to dress up their books.

Earlier, the European Central Bank added a total of $85.395 billion in U.S. dollar liquidity and also lent banks 42.185 billion euros in 91-day funds. The Bank of England and Swiss National Bank also lent U.S. dollars to banks.

The three-month dollar Libor rate slipped to 2.18 percent from around 2.20 percent on Tuesday while three-month euro and sterling Libor rates also eased. See

But the spread of three-month Libor over OIS rates for dollars widened to 179 basis points from 172 basis points. The sterling spread also widened but the euro spread narrowed a touch.

These spreads are seen as a gauge of banks' willingness to lend to each other -- a wider spread suggests less inclination to lend.

Overnight deposits at the ECB remained at elevated levels as banks continued to prefer holding cash rather than lend it on in interbank markets.

This week, the Federal Reserve started lending to money market funds via its new cash facility, the Money Market Funding Facility (MMIFF), while top U.S. banks have begun to tap the government-backed Temporary Liquidity Guarantee Program (TLGP), under which the Federal Deposit Insurance Corp will guarantee debt issued by financial institutions.

Goldman Sachs was first to use the TLGP programme with a $5 billion bond sale. Citigroup, JPMorgan, Morgan Stanley and Bank of America are reported to be preparing sales in what is expected to become a flood of new issuance.

Such programmes to inject funds into financial institutions and diversify their funding stream should eventually help ease money market strain.

"Governments and central banks are keeping up their efforts, and are nowhere near finished. We think near-dated LIBOR-OIS spreads and forwards will fall further," Mutkin added.

RATE CUTS

On Wednesday, the People's Bank of China (PBOC) lowered interest rates by 108 basis points, the biggest cut in about a decade and its fourth rate reduction since mid-September.

The ECB and Bank of England are widely expected to cut interest rates at their respective policy meetings next week.

After the turn of the year, the improvement in money markets should start to pick up, said Guillaume Baron, strategist at Societe Generale in Paris.

"But here again it depends a lot on market perception of the bank risk. Obviously all the measures we're seeing from the Fed, the ECB and from the governments and so on are a step in the right direction, but confidence has not come back," he added.

The five-year Credit Default Swap (CDS) of banks participating in the BBA's Libor fixing is currently at around 135 basis points, well above the 50 basis points seen a year ago and not far off the peak of 180 basis points seen after the collapse of Bear Stearns in March, suggesting confidence in banks was still lacking, Baron said.

This week, the Federal Reserve unveiled plans to buy debt issued by government sponsored mortgage enterprises and mortgage securities as well as a $200 billion facility to support consumer finance.

While that brought down mortgage loan rates, most money market spreads have yet to show any relief in credit conditions.

"The Fed program last night was more targeted toward the mortgage market and not the entire credit crisis," said Joseph Kraft, head of Japan capital markets at Dresdner Kleinwort.

"So it is not surprising to see the Libor and swap spreads not tightening that much."

(Additional reporting by Vidya Ranganathan in SINGAPORE; Editing by Toby Chopra) Keywords: MARKETS MONEY

(ian.chua@thomsonreuters.com; +44 207 542 7348; Reuters Messaging: ian.chua.reuters.com@reuters.net)

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