Money markets on a recovery path as states pump in cash

Tensed money markets, took a breather as the cost of borrowing dollars in London fell, rounding off the first weekly decline since July, after central banks around the world pumped unprecedented amounts of cash into money markets and governments backed loans.

The London interbank offered rate, or Libor, for three- month loans in dollars dropped for a fifth day, sliding 8 basis points, or 0.08 percentage point, to 4.42%, the British Bankers? Association said. It declined 40 basis points this week. The overnight rate for dollars slid 27 basis points to 1.67%, the lowest level since September 2004. Asian rates also fell.

?Libor rates continue to edge down, bringing the prospect of some rejuvenated interbank lending that little bit closer, even if it is still some way distant,? said Daragh Maher, deputy head of global currency strategy in London at Calyon, the investment-banking arm of French lender Credit Agricole SA.

Rates fell this week after central banks joined forces to offer lenders an unlimited supply of dollars and the European Central Bank did the same with euros. Still, the cost of borrowing between banks remains near record highs relative to the Federal Reserve?s benchmark rate of 1.5%.

While the reliability of the Libor-setting process has been criticized amid the global credit squeeze, it?s used to determine rates on $360 trillion of financial products worldwide, from mortgages to company loans and derivatives.

Also the cost of protecting high-risk, high-yield corporate bonds from default rose to a record in Europe after a report that U.S. housing starts fell more than forecast fueled concern of a global recession.

Credit-default swaps on the Markit iTraxx Crossover Index of 50 companies with mostly high-yield credit ratings increased 21 basis points to 758, and earlier traded as high as 765, according to JPMorgan Chase.

A basis point on a credit-default swap contract protecting 10 million euros ($13.4 million) of debt from default for five years is equivalent to 1,000 euros a year. European Union regulators also called Friday for a clear plan on valuing some of the shadowy high-risk credit derivative investments – estimated at around $600 trillion (euro444) trillion) – that are now a key issue in easing the global financial crisis.

Billions of euros (dollars) have been wiped off banks? balance sheets in recent months on fears that some complex investments may be based on assets that are nearly worthless – such as housing loans that may not be paid back when a recession puts people out of work.

The market for derivatives boomed over the last decade as investors sought new ways to parcel out risk, with many jumping on a gravy train that few really understood. Meanwhile money-market rates fell in Asia today. Hong Kong?s three- month dollar price slid 15 basis points to 4.2 percent, the biggest drop in three weeks. Japan?s one-month deposit rate dropped 25 basis points to 1.1 percent, heading for the biggest weekly decline since 2000.

?The market is starting to believe that central banks? policy actions are taking out some of the financial systemic risk,?? said Craig Saalmann, a Sydney-based credit strategist with JPMorgan Chase. According to Sherman Chan, economist, Moody?s Economy.com boosting liquidity in the financial system and injecting capital into struggling banks are now the two key priorities of policymakers. Fears of a dramatic economic downturn have prompted governments to introduce fiscal stimulus packages. Asian economies will not necessarily benefit from continued solid economic development in China, if import substitution is becoming a trend.

Strengthening the capital and liquidity positions of the banking system are now the key priorities of policymakers. Many governments around the world have provided local financial institutions with temporary guarantee arrangements?either introducing it or upgrading the existing policy?for deposits and loans, in a bid to stabilize their domestic banking system. It is a domino effect that began in Ireland, prompting the rest of the EU to soon follow suit, and is now spreading across the Asia-Pacific.