Overnight bank rates fall, U.S. CP market shrinks

LONDON/NEW YORK (Reuters) - Overnight interbank borrowing cost fell on Thursday in the wake of deep rate cuts from global central banks this week to thaw credit markets, but longer-term funding costs stayed high.

Stubbornly high bank-to-bank lending rates have stymied funds from flowing into other parts of the money markets such as commercial paper, which continued to contract despite several maneuvers unveiled by the Federal Reserve.

While lower overnight interest rates will prevent further deterioration in the global credit crisis for now, elevated term borrowing costs will hurt cash-strapped companies and consumers in the long run, damaging the global economy, according to analysts.

The British Bankers Association's latest daily fixing of London interbank offered rates (Libor), which are global rate benchmarks, showed the cost of overnight dollar, euro and sterling funds fell sharply, but by less than a half- percentage point.

"We're not seeing any relief in term Libor fixings, which tells us that the rate cut has exclusively impacted on the overnight market, but it hasn't touched the Libor market at all," said BNP Paribas rate strategist Alessandro Tentori.

"And that's not a very good sign," he added.

That was the size of rate cut delivered by the Federal Reserve, European Central Bank and Bank of England on Wednesday as central banks around the world acted in unison to fight the deepest financial crisis in 80 years and stave off recession.

But this unprecedented move has not jump-started lending in any significant degree. One of the problem spots has been the stubborn rise in borrowing costs in the U.S. commercial paper market, a critical source of day-to-day funding for companies.

OVERNIGHT RATES

Overnight euro Libor was fixed lower at 3.93625 percent, close to the ECB's new 3.75 percent target.

But overnight dollar Libor at 5.09375 percent and overnight sterling at 5.41875 percent were still significantly above the Fed and BoE's targets of 1.5 percent and 4.5 percent, respectively.

Indeed, the cost of borrowing dollars for any period beyond overnight rocketed -- three-month dollar Libor hit its highest this year -- as banks continued to scramble for greenbacks to cover dollar positions and exposure, as well as to fund dollar assets.

Three-month dollar Libor was fixed at 4.75000 percent, its highest this year. Three-month euro Libor posted its first decline in almost a month, but at 5.38625 percent remained near Wednesday's record high.

The continued money market dislocation came despite the coordinated rate cuts and unilateral steps taken by several countries and monetary authorities. The ECB, for example, cut in half the premium it charges banks for emergency overnight borrowing, raised the amount it pays on overnight deposits and offered unlimited weekly funds at a fixed rate.

COMMERCIAL PAPER LIMPS ALONG

U.S. data showed the vital commercial paper market shrank for a fourth straight week, even after the Fed announced a program to buy these short-term corporate IOU's.

The amount of commercial paper outstanding in the week ended Oct 8 fell to $1.551 trillion, the lowest in more than three years and off $56.4 billion from the prior week.

Average U.S. overnight CP rates for "AA"-rated, or mid-investment grade, nonfinancial companies fell 35 basis points to 2.27 percent on Wednesday, but the average overnight CP rates for bank and financial companies rose 5 basis points to 2.59 percent, according to Fed data.

The Fed's various measures have not been quick fixes for the CP market, but they will eventually help.

"People act on a lag. It's not a night-and-day difference," said Deborah Cunningham, chief investment officer for Federated Investors' taxable money markets, on Wednesday. "But people are gaining confidence and that confidence is what is needed to restore normal operations, and it's coming back slowly."

Meanwhile, in other parts of the world, the Bank of Japan and Reserve Bank of Australia carried out major short-term liquidity injections on Thursday to help ease the credit squeeze, and the BoE and ECB followed up by pumping billions more in short-term dollar funds into the system.

(Additional reporting by Muralikumar Anantharaman in Boston)