Interbank dollar pressures ease as banks lend

* US dollar funding pressures ease as banks lend dollars

* 2-yr dollar swap spread falls to lowest in a month

* Libor expected to fix lower as c.banks gain traction

By Jamie McGeever

LONDON, Oct 20 (Reuters) - The rate at which banks lend dollars to each other fell on Monday as dealers reported U.S. banks starting to lend rather than simply hoard cash, a sign central banks are gaining traction in their quest to unclog frozen money markets.

Two-year dollar swap spreads fell to their lowest in a month, while euro and sterling interbank rates were also indicated lower in European trading on Monday.

Dealers on Friday had said one large U.S. bank lent up to $20 billion in one-month dollar funds, bringing one-month interbank rates down to 3.95 percent from around 5 percent.

"They fall into the category (very small) of quality banks where everyone has put their cash," said the head of rates trading at one bank, referring to the U.S. bank in question.

"They are very long cash," he said.

Interbank activity was quiet early on Monday, dealers said. But that shouldn't stop London interbank offered rates (Libor), especially dollars, from continuing their broad fall since U.S. and European authorities undertook sweeping measures over a week ago to shore up their banks and financial systems.

"The fixings continue to come off quite a bit. Perhaps if equity markets recover for a few weeks from this point we might see the first bits of real confidence returning to the markets," said a money markets trader in The Netherlands.

A fall in dollar interbank rates is critical to getting gummed up global money markets functioning again.

A particularly acute shortage of dollars in European and Asian trading hours since the collapse of Lehman Brothers in mid-September exacerbated the global credit crunch as banks hoarded dollars to bolster their own balance sheets rather than take the risk of lending it out.

But government and central bank efforts, including huge injections of public funds into banks, cross-border currency swap lines and relaxation of collateral rules have eased some of the tight liquidity conditions caused by the credit crisis.

In London trading on Monday interbank rates for overnight dollar deposits were indicated in a range of between 0.5 and 1.5 percent compared with 1-1.5 pct on Friday, Reuters data showed.

Three-month dollar deposit rates on Monday were indicated in a narrower range of 3.4-4.25 percent versus 4.25-4.8 percent early in London on Friday.

LIBOR SEEN FALLING FURTHER

Three-month sterling rates were indicated down around the 5 percent area , the lowest in a week and three-month euro rates in a range of 4.6-5.1 percent compared with 4.9-5.04 percent early on Friday .

The Bank of England on Monday acted to make it easier for commercial banks to get short-term funding, implementing new measures announced last week to free up UK money markets. For more, see [ID:nLK227951].

There is typically a premium on deposit rates over Libor fixings because Libor is taken from a smaller sample of large banks in the market.

Deposit and Libor rates are only indicative prices of where banks are lending to each other, not necessarily the levels at which lending is actually being carried out.

Many Libor rates were fixed sharply lower on Friday -- particularly short-dated rates -- and market participants expect further declines at Monday's fix from the British Bankers Association between 1000 and 1100 GMT.

Estimates from two European banks on Monday put one-month dollar Libor fixing around 3.75-80 percent compared with 4.18125 percent on Friday, three-month Libor around 4.05-15 percent versus 4.41875 percent and one-year Libor at 3.65-70 percent compared with 3.97250 percent on Friday.

"Based on strong dollar term flows, the BoE money market reform and the (European Central Bank's) easing of lending conditions last week, we expect more rapid declines in Libor rates over the coming days," said Lena Komileva, head of G7 strategy at Tullet Prebon.

"In contrast to earlier weeks, increased interbank liquidity means the declines in Libor are more than just a symbolic feature of an improved risk environment," she said.

In further signs interbank strains are easing, two-year dollar swap spreads narrowed on Monday to a one-month low of 106 basis points from around 116 basis points late in New York on Friday. Two-year euro swap spreads fell to as low as 101 basis points from around 108 basis points on Friday, the lowest in two weeks.

Swaps spreads measure the difference between the cost to exchange fixed for floating rate interest payments in the swaps market, and government borrowing costs over the same time frame. Narrowing spreads are generally considered a sign of improving financial market conditions.

South Korea was the latest government to join the global drive to support the banking system, unveiling a package worth over $130 billion of state guarantees on foreign debt and a promise to recapitalise financial firms if necessary. See [ID:nSEO366228].

Governments around the world have pledged about $3.3 trillion -- about equal to the economic output of Germany -- aimed at boosting interbank lending and shoring up their economies amid the global credit crisis.