* Dollar 3-month Libor falls to lowest since early June
* U.S. commercial paper issuance slows again
* Europe strains evident; ECB sees record o/n deposits
(Recasts, adds comments, changes dateline, prv LONDON)
By Richard Leong
NEW YORK, Nov 4 (Reuters) - Longer-term interbank lending rates for U.S. dollars fell to a five-month low on Tuesday, but the recovery in the U.S. commercial paper market showed signs of fatigue.
In a further sign that the global credit crunch is far from over, the European Central Bank said banks deposited a record 280 billion euros at the central bank overnight on Monday, suggesting banks would still rather park cash at the ECB for low return than it lend out.
"We are generally in better shape, but we are not out of the woods," said Jason Brady, portfolio manager at Thornburg Investment Management in Santa Fe, New Mexico.
The flood of U.S. dollar liquidity pumped into the global banking system after the collapse of Lehman Brothers in mid-September, together with aggressive interest rate cuts around the world, have calmed the panic and eased the worst of the credit crisis.
The most encouraging indicator over the past three weeks have been the decline in the interbank rates on unsecured dollar funds. Their drop has been perceived to show greater willingness among banks to lend to each other and cash-strapped borrowers.
The London interbank offered rates (Libor) for three-month
dollar funds at the British Bankers' Association's daily fixing
was 2.70625 percent
Euro and sterling Libor rates also fell but by smaller margins, suggesting the thawing of frozen money markets remains more concentrated in dollars.
The dollar Libor/OIS spread -- the closely-watched premium paid for interbank dollar borrowing over anticipated official policy rates as measured by Overnight Index Swap rates -- narrowed much more than euro or sterling spreads too.
COMMERCIAL PAPER SUPPLY SLOWS
The steep decline in three-month dollar Libor since Monday can be partly attributed to the improvement in the U.S. commercial paper market in the wake of the Federal Reserve's purchase program to support this class of corporate debt.
Daily supply of commercial paper fell for a third straight session on Monday, according to Fed data released on Tuesday.
A particularly troubling sign was a plunge in the issuance of 81-day-plus CP from banks and financial companies. In fact, they issued none of these longer-maturity CP on Monday, compared with $7.47 billion on Friday. See [ID:nN04325788]
"The CP market is still a bit of a mess," Thornburg's Brady said, adding that investors like money market mutual funds still favor overnight paper despite Fed's backstop for three-month CP.
In the meantime, the Investment Company Institute, a U.S. mutual fund industry group, said it had created a working group to develop recommendations to improve the workings of the money market and regulation of how funds are invested in that market. For more, see [ID:nN04540203]
EUROPE LAGGING?
The dollar Libor/OIS spread narrowed to around 210 basis points from around 225 basis points, the smallest gap since late September shortly after Lehman Brothers went bankrupt.
Libor/OIS spreads on euros and sterling have not matched the tightening with their dollar counterpart, analysts said.
"If the pace of narrowing in the U.S. continues, the sterling and euro markets will start to look like laggards," said Laurence Mutkin, head of European rates strategy at Morgan Stanley in London.
The three-month sterling Libor/OIS spread was last indicated around 226 basis points and the euro spread around 180 basis points.
The ECB performed an array of market operations on Tuesday. The ECB and the Bank of England injected a combined $83 billion in 84-day dollar liquidity into the financial system, and the ECB allotted $650 million in a parallel currency swap.
Moreover, the ECB and the Swiss National Bank announced three-month euro-Swiss franc currency swaps. [ID:nL459129]
Meanwhile, Australia's central bank cut interest rates by three quarters of a percentage point to 5.25 percent to limit the effect of the financial crisis on the real economy, an aggressive move which some analysts say the ECB and BoE could replicate later this week.
(Additional reporting by Jamie McGeever in London)