Thursday May 28, 10:17 PM
MONEY MARKETS-Dollar borrowing costs slip but strains remain
By John Parry and George Matlock
NEW YORK/LONDON, May 28 (Reuters) - Bank-to-bank three-month dollar borrowing costs fell on Thursday, snapping a two-day rise, but money markets remain strained and fears about counterparty risk are not far beneath the surface.
Governments and central banks are slowly paring back their huge injections of money into the banking system, made during the nearly two-year-old global financial crisis, as Federal Reserve data released on Thursday showed.
Banks are gingerly lending to each other, but borrowing costs are above their historical norms, albeit dramatically lower than during the market panic of late 2008 after Lehman Brothers (NYSE: LEH - news) collapsed.
The storm of systemic contagion which this event and last-ditch government rescues of failing financial institutions unleashed on global markets has calmed considerably. But last year's financial markets tempest is being overshadowed by a deep economic crisis that is further denting banks' balance sheets and stalking short-term lending markets.
Federal Reserve data released on Thursday showed the U.S. commercial paper market shrank to the lowest level outstanding in eight years, undermined by both the global credit crisis and the most prolonged U.S. economic downturn in decades.
For the week ended May 27, the size of the U.S. commercial paper market fell by $35.9 billion to $1.248 trillion outstanding, the lowest since 2001, according to Reuters EcoWin data.
'I regard the data as a sign of continued stress in the commercial paper market,' said Howard Simons, strategist with Bianco Research in Chicago.
Commercial paper is a vital source of short-term funding for routine operations, such as inventory purchases and payroll at many companies and banks.
'We have both a drop in demand for short-term capital and you are not getting people to step up to the plate to supply commercial paper because the market is still dysfunctional,' Simons said.
In interbank lending markets, three-month sterling funds edged up to 1.27813 percent from 1.27625 percent on Wednesday, according to Libor fixings from the British Bankers' Association. For more see.
Libor or the London interbank borrowing rate is the leading global benchmark to which short-term borrowing costs are referenced.
However, dollar-denominated interbank lending rates slipped for the first time in two sessions. Three-month dollar-denominated Libor fell to 0.66750 percent on Thursday from 0.67375 percent on Wednesday, according to the latest daily fixing from the British Bankers' Association.
For the previous two days the dollar rate had edged higher. Interbank Libor rates' plunge to record lows since March had overreached as banks gradually reduced reliance on central bank funding facilities, some analysts said.
Analysts expect Libor may now settle into a new range above key central bank lending rates that is higher than historical norms.
U.S. banks borrowed a bit less from the Federal Reserve in the latest week, hinting that reliance on the lender of last resort was very slowly abating.
Overall, banks' direct borrowings from the Fed averaged $124.23 billion per day in the week ended May 27, down from $127.93 billion per day in the previous week, Fed data released on Thursday showed.
The Fed's balance sheet liabilities -- a broad gauge of its lending to the financial system -- declined to $2.064 trillion on May 27 from $2.165 trillion on May 20.
(Additional reporting by Burton Frierson and Pedro Nicolaci da Costa; Editing by James Dalgleish) Keywords: MARKETS MONEY
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