NEW YORK, April 18 (Reuters) - Spreads on U.S. interest
rate swaps tightened on Friday, as demand emerged in late
trading and lowered the cost to exchange fixed-rate for
floating-rate payments.

The market recovery partly came from players booking
profits on this week's spread widening trades and positioning
ahead of next week's fund auction from the Federal Reserve's
term auction facility (TAF), analysts said.

Risk premiums on swaps over Treasuries initially rose as
interest rates on overseas dollar deposits jumped for a third
consecutive day on concerns about the credibility of interbank
borrowing costs.

The three-month London interbank offered rate -- the
benchmark on the floating-rate leg of a swap contract -- posted
its biggest weekly rise since mid-August in the beginning of
the current global credit crunch.

Three-month Libor jumped to 2.90750 percent on Friday, up
19 basis points on the week.

Two-year swap spreads ended at 90.75 basis points after
widening out as much as 98.25 basis points in early trading.
The two-year swap was at 95.50 basis points late Thursday.

Longer swap spreads also recovered from an earlier
widening. The 10-year spread finished at 65.75 basis points
from 70.00 basis points.

But spreads were sharply wider on the week. Two-year
spreads expanded 8 basis points and 10-year grew 2 basis
points.

LIBOR JITTERS

There has been growing speculation that banks surveyed
daily for Libor have been understating their actual borrowing
costs in a move to mask cash needs.

If Libor settings were understating banks' actual borrowing
costs, it would prove the global credit crisis is far from over
and undermine the view that banks and financial companies have
cleaned up their balance sheets and are ready to crank up
lending, according to analysts.

"This Libor distortion -- if it proves to be real -- is yet
another example of how the credit crisis is still alive,"
Robert Brusca, chief economist at Fact and Opinion Economics,
wrote in a research note on Friday.

While there has been no evidence of wrong-doing, the
British Bankers Association that oversees Libor said earlier
this week it will bar from its rate-setting process any of the
banks that distort the market.
(Reporting by Richard Leong; Editing by Leslie Adler)