Money markets libor ends week higher for first time this year

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The cost for banks to borrow three-month, unsecured dollar-based funds increased this week, posting the first weekly rise in 2012 as the positive effects of cheap central bank loans on funding levels appeared to taper off. The three-month dollar London interbank borrowing rate, or Libor, a benchmark for interest rate swaps and other products, was stable on Friday at 0.47365 percent, but ended the week higher after declining to 0.47355 percent a week ago. The rate has fallen from over 0.58 percent at the beginning of the year, in large part driven by improved market liquidity since the European Central Bank first offered cheap three-year loans in December."A large part of the initial decline was driven by excess liquidity introduced by the ECB," said Amrut Nashikkar, analyst at Barclays Capital in New York."Now it has had its impact and there is no additional liquidity being pumped," he added. "The only reason for sustained downward pressure from this point on would be fundamentals improving in peripheral Europe."The ECB loans have shored up bank funding levels and reduced fears of cascading defaults as banks struggle with exposures to risky sovereign debt in the region and as investors including U.S. money funds remain relatively cautious of lending to the area.

At the same time, investors remain wary that the region could face additional stress as nations grapple with high debt levels and slowing growth, and some fear that countries including Portugal may need to undergo similar debt swaps to Greece, which would be costly for the bond holders. The three-month dollar Libor rate remains much higher than the 0.25 percent area it traded at in mid-2011, before concerns about European bank health intensified. Barclays' Nashikkar recommends entering into positions such as interest rate swap spread wideners to take advantage of any renewed tick in the rate.

"When Libor was dropping there tended to be quite a bit of momentum, but since that has stabilized the market is more susceptible to widening in spreads," he said. Two-year interest rate swaps, which are also used as a proxy for bank credit risk, tightened half a basis point to 25.25 basis points on Friday. They have tightened from over 30 basis points in late February and more than 50 basis points in early January.

EURODOLLARS EXTEND DECLINE Most Eurodollar futures contracts dropped on Friday to their lowest levels this year as Treasuries also continued their price decline, though the pace of the selloff was stemmed by some weaker-than-expected inflation data. U.S. core consumer prices rose by 0.1 percent in February, lower than expectations of a 0.2 percent rise, while prices including the volatile food and energy category came in as expected with a 0.4 percent increase in the month."It came in a little softer than expected. If it had gone the other way, I think the market definitely would have continued to sell off," said Michael Chang, an interest rate strategist at Credit Suisse in New York. Bonds and futures have sold off dramatically this week as investors adjust expectations towards stronger economic growth and a reduced likelihood that the Federal Reserve will undergo a new round of bond purchases. Friday's data, however, "gives the Fed some room, some flexibility to stay dovish and not be forced by the market to deviate from the current course," Chang added.