Libor for overnight dollar loans jumps as credit freeze deepens

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Oct 7: The cost of borrowing in dollars overnight in London jumped as UK lenders held talks with the government on emergency funding and Iceland nationalised its second-biggest bank amid an unprecedented credit squeeze.

The London interbank offered rate, or Libor, that banks charge each other for such loans rose 157 basis points to 3.94% on Tuesday, the British Bankers’ Association said. The corresponding rate for euros climbed 22 basis points to 4.27%, the highest in four days. The Tokyo interbank rate stayed at the highest level this year and the Libor-OIS spread, a gauge of cash scarcity among banks, widened to a record.

“There’s still a massive lack of confidence in this market and the more we talk about it, the more it becomes a self- fulfilling prophecy,” said Jan Misch, a money-market trader in Stuttgart, Germany, at Landesbank Baden-Wuerttemberg. “Sentiment hasn’t improved much and rates remain at elevated levels.”

The seizure in global credit markets is deepening on speculation central bank attempts to revive lending between financial institutions won’t work, resulting in more bank failures. The UK government may invest $79 billion in some of the nation’s banks to bolster their capital, two people familiar with the matter said. Iceland said it’s negotiating a 4 billion- euro ($5.43 billion) loan from Russia and took control of Landsbanki Islands hf, its second-largest lender.

The Libor-OIS spread, the difference between the three- month dollar rate and the overnight indexed swap rate, climbed 2 basis points to 290 basis points on Tuesday. The average was 8 basis points in the 12 months to July 31, 2007, before the credit squeeze.

Libor, set every morning in London, determines prices for financial contracts valued at $393 trillion as of December 31, 2007, or $60,000 for every person in the world, and helps set consumer interest rates on everything from home loans to credit cards.

Banks yesterday lodged 42.6 billion euros ($58 billion) in the European Central Bank’s overnight deposit facility, up from 38.9 billion on October 3. They also borrowed 13.6 billion euros from the ECB at the emergency overnight marginal rate. The ECB’s deposit rate is 3.25% and the marginal lending rate is 5.25%.