Interbank rates ease slightly ahead of Bank decision

By George Matlock and John Parry

LONDON/NEW YORK (Reuters) - The cost of interbank borrowing fell on Wednesday, but short term funding markets remain impaired by the global credit crisis and banks are still wary of lending to each other.

The European Central Bank and Bank of England were back in the market offering liquidity one day before a likely cut in UK interest rates of at least 50 basis points to a record low of 1.5 percent.

The interbank cost of borrowing dollar, euro and sterling funds mostly fell on Wednesday, according to the daily fixing from the British Bankers' Association, but there was little lending, even though the turn of the calendar year has eased pressure to add to cash reserves.

"We got by yet another huge hurdle: year end," said T.J. Marta, fixed income strategist with RBC Capital Markets in New York.

The spread of three-month London interbank offered rates over OIS (Overnight Index Swap) rates for dollars narrowed on Wednesday to 122 basis points from 124 basis points the previous session.

"Certainly things are still broken, but improving," Marta said, adding that he expects spreads between Libor and OIS to grind narrower as the year goes on.

However, signs of improvement are muted, Marta said. Before U.S. investment bank Lehman Brothers collapsed in September, that spread was about 75 basis points and before the global credit crisis erupted in August 2007 it was steady, near 17 basis points, so current indications are that short-term lending markets remain seriously disrupted.

With bourses falling and two-year interest rate-sensitive euro zone government bond yields falling to levels not seen since at least 1990, risk aversion remained high, albeit less than the heady levels seen in 2008.