Libor rates ease despite new bank worries

inspector_monkfish

13:13 28Apr09 MONEY MARKETS-Libor rates ease despite new bank worries
* WSJ report suggests Citigroup, BoA need capital
* 3-mth dollar Libor falls to lowest since mid-2003
* Dollar spread tightens further


LONDON, April 28 - The rate that banks charge each other to borrow three-month dollar funds fell to a near 6-year low on Tuesday, despite news that fuelled concerns about the capital health of some major U.S. banks.

The Wall Street Journal reported U.S. regulators have told Bank of America Corp <BAC.N> and Citigroup <C.N> they may need to raise more capital following stress tests of banks' ability to withstand the economic crisis.

"Today's news suggests the financial sector is far from out of the woods and that the underlying picture is one of continuing fragility," said Nick Stamenkovic, strategist at RIA in Edinburgh.
"But clearly the market is confident financial systems are going to be stabilised by all the actions by central banks."

Since the collapse of Lehman Brothers in September last year, which caused the interbank money market to freeze up as banks became wary of lending to one another, central banks have stepped in, pumping massive liquidity into the system.

These actions have helped take some pressure off the money market, but with lenders still struggling to mend their balance sheets, central banks are expected to continue playing a big role in nursing the industry back to health.

"That'll remain a key support for the financial sector and for spreads. So even if we see negative news, as we saw today, I think they'll have a limited impact," Stamenkovic added.

"The FOMC statement tomorrow will show the Fed is still worried about the economy ... hence, they'll continue to use all policies at their disposal to ensure there'll be a recovery down the road."

The three-month dollar London interbank offered rate (Libor) was fixed at 1.03938 percent -- the lowest since mid-2003. Equivalent euro and sterling rates were also lower.

The premium that the three-month dollar Libor trades over the Overnight Index Swap rate, or anticipated central bank rates -- a gauge of money market stress -- eased 2 basis points to 86 basis points -- the lowest since early September, before the collapse of Lehman Brothers.

At the height of the banking crisis, the spread blew out to above 360 basis points, whereas before the crisis started in around mid-2007, it consistently traded near 10 basis points.

Still, some analysts warned the risk is that renewed bank concerns could halt the gradual fall seen in those premiums in the near-term.
"This might prove to be a short term trough in all those spreads," said Sally Auld, an interest rates strategist at JPMorgan Chase in Australia.

The U.S. government will release the outcome of its stress tests on its biggest banks next week, and these are meant to reveal which of them can cope without additional capital injections.