Money Market Rates Tumble; Central Banks Inject Funds (Update8)

By Gavin Finch


Dec. 18 (Bloomberg) -- The cost to borrow in euros plunged after the European Central Bank added an unprecedented $500 billion to the banking system as part of a global effort to ease credit-market gridlock through year-end.

The two-week euro interbank offered rate dropped a record 50 basis points to 4.45 percent, the European Banking Federation said today. The rate had climbed 83 basis points in the past two weeks as banks anticipated a squeeze on credit through the end of the year.

``These are strong-arm tactics intended to show the market they're seriously committed to breaking the deadlock,'' said Marc Ostwald, a fixed-income strategist at Insinger De Beaufort SA in London. ``The ECB is helping to bankroll banks out of a problem that they themselves created.''

The decline may signal that policy makers, in their first coordinated action since Sept. 11, 2001, are making headway in reviving lending between banks. The credit-market crisis has caused banks from UBS AG to Deutsche Bank AG to report writedowns on securities linked to U.S. subprime mortgages, and sent money-market rates soaring.

The Bank of England also held the first of two special operations today, offering three-month loans in pounds. Yesterday, the Federal Reserve auctioned one-month cash in dollars, the first of four such operations.

The central bank measures have had mixed results. The one- month dollar rate fell 2 basis points to 4.95 percent, 70 basis points more than the Fed's key rate, according to the British Bankers' Association. The cost of three-month loans in pounds declined 4 basis points to 6.39 percent, 89 basis points more than the Bank of England benchmark, the BBA said.

`Fundamental Issues'

The ECB action ``doesn't address the fundamental issues of banks hoarding cash and while the central bank has succeeded in stabilizing the shorter-term rates, it makes little impact on the longer-term rates,'' said Lena Komileva, an economist at Tullett Prebon in London.

The cost of borrowing euros for two weeks is still 45 basis points higher than the ECB's benchmark financing rate. It was 9 basis points higher at the end of June.

The ECB loaned 348.6 billion euros ($501.5 billion) for two weeks at 4.21 percent today, almost 170 billion euros more than it estimated was needed. It was the Frankfurt-based bank's biggest open-market operation.

TED Spread Narrows

The TED spread, or difference between what the U.S. government and banks pay for three-month loans, narrowed for a fifth day to 189 basis points, indicating an increased willingness among banks to lend. The spread was 35 basis points at the start of the year.

Bids were received from 390 banks, ranging from 4 percent to 4.45 percent, the ECB said today. The central bank first offered extra cash on Aug. 9, when it lent 95 billion euros of emergency funds. Banks also borrowed about 2.4 billion euros at 5 percent yesterday, the most since Sept. 26, the ECB said.

The three-month euro-borrowing rate fell 7 basis points to 4.88 percent, down from near a seven-year high, the EBF said.

``Maybe this is the sign we've all been waiting for that a peak in Libor has been reached,'' said Patrick Jacq, a fixed- income strategist at BNP Paribas SA in Paris. ``It's a definite sign of an improvement in the market.''

The cost of borrowing in dollars for two weeks increased 1 basis point to 5.10 percent, the BBA said today. The Fed yesterday offered $20 billion in one-month loans. The results will be announced tomorrow.

BOE Operation

The corresponding rate for pounds soared a record 77 basis points to 6.51 percent, the BBA said. Today is the first day that pound-denominated loans cover a borrower's commitments through the end of the year.

The Bank of England offered 10 billion pounds ($20 billion) of three-month cash. It received 10.9 billion pounds of orders for the loans, lending at an average of 5.949 percent. The central bank's benchmark interest rate is 5.5 percent.

Central banks in the U.S., U.K., Canada, Switzerland and the euro region are responding to subprime mortgage-related losses at financial institutions including Citigroup Inc., Merrill Lynch & Co. and Bank of America Corp.

Goldman Sachs Group Inc. estimated last month losses related to record home foreclosures in the U.S. may be as high as $400 billion for financial companies. If accurate, banks, brokerages and hedge funds would need to cut lending by $2 trillion, triggering a ``substantial recession,'' the firm said.

U.S. corporate defaults probably will quadruple next year after the number of companies that lost their investment-grade credit ratings rose at the fastest pace since 2003, according to Moody's Investors Service.