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%.

In Asia, Japan and Australia’s central banks pumped more than $11 billion into markets in an attempt to revive lending. The Reserve Bank of Australia also slashed its benchmark interest rate by a whole percentage point, twice as much as economists forecast, raising speculation policy makers around the world may act together to cut borrowing costs.

There is “speculation the Federal Reserve could announce new measures and that we could see coordinated rate cuts,” said Christoph Rieger, a fixed-income strategist at Dresdner Kleinwort in Frankfurt. “I don’t think the cuts will happen as quickly as some people are expecting.”

The TED spread, or the difference between what banks and the Treasury pay to borrow money for three months, was at 370 basis points today, from 382 percentage points yesterday. It was at a record 391 basis points earlier.

The UK government bailed out Bradford & Bingley Plc and brokered the takeover of HBOS Plc by Lloyds TSB Group Plc in the past month, after earlier this year taking Northern Rock Plc into state ownership, as the credit-market crisis spread to Europe’s second-largest economy.

Iceland, which had its credit ratings reduced by Standard & Poor’s yesterday, today pegged its currency to a trade-weighted index as it sought to contain a crisis that’s pushed the krona down as much as 31% against the dollar in the past 30 days. The central bank also gave a 500 million-euro loan to Kaupthing Bank hf, the nation’s largest lender.

Financial institutions have incurred $585 billion in writedowns and losses since the collapse of the US subprime- mortgage market in early 2007. Governments in Europe and the US arranged rescues for six financial institutions in the past two weeks. The Tokyo three-month interbank rate held at 0.87%, the highest since last year, and the corresponding rate in Singapore rose 1 basis point to 4.24%, near the highest since January. Taiwan’s overnight lending rate increased 8 basis points to 2.11%.