* Bank of England cuts interest rates 50 bps to 1.5 percent

* 3-mo sterling rate/OIS spread seen narrowing post-BoE

* Korean markets prepare for a deep rate cut

* Dollar interbank rates dip to 4-1/2 year lows in Asia

By George Matlock

LONDON, Jan 8 (Reuters) - The bank-to-bank cost of borrowing
dollar, euro and sterling funds fell across all benchmark
maturities on Thursday as risk appetite returned to money
markets and the Bank of England cut interest rates.

This was also reflected in the 2-year dollar swap spread
USD2YTS=RR SMKR99 which was quoted at 56 basis points in
Europe - down from around 70 basis points seen on Wednesday and
at its narrowest since just before the U.S. subprime mortgage
crisis erupted in Aug. 2007.

The two-year U.S. swap spread -- a gauge of counterparty
risk and thus financial system stress -- has now shrunk about 50
basis points since the Fed slashed rates to virtually zero on
Dec. 16.

The three-month London interbank offered rates (Libor) for
dollar, euro and sterling funds eased at the London fixings, the
British Bankers' Association said, minutes before the BoE's
Monetary Policy Committee decided to cut UK interest rates by 50
basis points to 1.5 percent - their lowest in the central bank's
315-year history - at 1200 GMT.

The Bank said credit conditions had tightened and added that
there was "the need for further measures to increase the flow of
lending to the non-financial sector", suggesting a path to
quantitative easing.

"Whilst we have not seen any real evidence of quantitative
easing from the BOE, the likelihood is increasing as the central
bank is much focused on getting lending back to more normal
levels," said Carl Hammer, an analyst at SEB in Stockholm.

"This will be important going forward without further
significant improvements in the transmission mechanism of
monetary policy," he added.

UK policymakers have been frustrated that a spate of recent
rate cuts have not been passed on in full to borrowers.

The spread of three-month London interbank offered rates
over OIS rates for dollars and sterling narrowed but was
unchanged for euros.

The spread expresses the three-month premium paid over
anticipated central bank rates, or Overnight Index Swap rates
and is seen as a gauge of banks' willingness to lend to each
other -- a wider spread is seen as an indication of decreased
inclination to lend.

"We have seen Euro Libor and sterling Libor easing in recent
weeks but what has been most apparent today is that markets
indicated the sterling/OIS spread narrowing. After the BoE
decision, March futures are indicating that the spread could
narrow by 60 basis points to 100 bps by March," said Christoph
Rieger, interest rate strategist, at Dresdner in Frankfurt.

"On current levels, that would suggest the spread narrowing
by 5-10 bps on Friday. If it doesn't, that means the market is
too ambitious on this and it would be the right time to sell the
March short sterling future and to receive Sonia swaps," he
added.

But Rieger said caution was necessary "and it is not wise to
read too much into the levels right after a UK rate cut. On
Friday we will have a clearer idea of market direction."

DOLLAR RATES SOFTER

Meanwhile, in spite of the grim jobs news and a selling of
Treasuries in anticipation of a big surge in supply of
government debt, dollar money market rates continued to soften
USD3MD=.

Three-month U.S. dollar interbank rates traded in Singapore,
meanwhile, hit a 4-1/2-year low SIUSD3MD=ABSG, feeding off the
huge amounts of cash still being pumped in by central banks.

The TED spread TEDCASH, or premium investors pay for
3-month interbank lending over comparable Treasury yields, was
last seen lower at 125 bps and compared with 137 bps on the last
day of 2008.

KOREA MOVE

Earlier, South Korean money market curves steepened on
Thursday led by plunging short-end rates after the government's
bleak economic report and Taiwan's emergency rate cut the
previous day, while dollar rates extended their decline.

Korean analysts had forecast a half percentage point cut in
the base rate at Friday's policy review [ID:nSEO2182] in a
Reuters poll earlier this week.

But the sharp 67 basis points drop in the 3-month
certificate-of-deposit rate KRCD=KQ to 3.25 percent on
Thursday showed markets were preparing for a possibly much
deeper rate cut.
(Editing by Stephen Nisbet)