(Adds fed funds data)
NEW YORK, Oct 31 (Reuters) - A key gauge of interbank borrowing costs for U.S. dollars rose on Wednesday, marking its largest monthly increase since March, amid worries about rising Treasury bill supply and the Federal Reserve’s reduction of its balance sheet.
The London interbank offered rate for banks to borrow three-month dollars from each other climbed 1.75 basis points to 2.5585 percent, the highest since October 2008.
For October, LIBOR surged 16.0 basis points, which was the biggest increase since a 29.5 basis-point jump seven months ago.
LIBOR is the rate benchmark for $200 trillion of dollar-denominated financial products, mainly interest rate swaps and floating-rate loans.
Other key U.S. money market rates remained elevated.
The three-month overnight indexed swap (OIS) rate , which reflects traders’ expectations on the federal funds rate, edged up to 2.285 percent from 2.279 percent.
The gap between three-month LIBOR and OIS grew to 27.4 basis points, its widest since Aug. 16, from 26.2 basis points on Tuesday.
This spread expands as it becomes more costly for banks to borrow from one another. Some analysts see a growing LIBOR/OIS spread as a sign of tightening financial conditions.
The federal funds rate averaged 2.20 percent on Tuesday for a sixth consecutive day, according to New York Federal Reserve data released on Wednesday.
The “effective” fed funds rate is the average cost of what banks charge each other to borrow excess reserves overnight.
The effective fed funds rate and the interest the Fed pays banks on excess reserves that they leave with the U.S. central bank (IOER) remained at parity.
If the effective fed funds rate rises above IOER, some analysts say, the Fed would be seen as losing its grip on controlling short-term borrowing costs.
They expect Fed policymakers may increase IOER by a smaller amount if officials were to raise the Fed’s overall interest rate target range at their Dec. 18-19 meeting.
Reporting by Richard Leong Editing by Chizu Nomiyama and Bernadette Baum