Action by European leaders next week to tackle the sovereign debt crisis will determine whether dollar funding costs stay lower after the world's leading central banks' joint effort on Thursday sent rates down. The co-ordinated move came before eurozone leaders meet on December 9 with financial markets expecting significant steps towards deeper fiscal integration and signs of a heightened sense of urgency to draw a line under the crisis.
European banks have been finding it harder to borrow dollars in recent months as US money market funds and financial institutions scaled back short-term loans to them fearing some banks' exposure to bad debt from struggling eurozone states means they are insolvent.
As the debt crisis threatened ever bigger economies such as Italy and France, the costs of raising dollars rose dangerously close to the 2008 crisis-era highs, increasing pressure on authorities to alleviate the stress. Government debt sales in France and Spain on Thursday attracted solid demand and at lower yields than feared - although still at 14-year highs, indicating an improving backdrop, analysts said.
"It is of a fairly minimal importance in terms of the structure of the whole crisis," said Mark Schofield, head of rate products strategy at Citi in London. "It doesn't necessarily do anything to protect banks from a systemic risk in the event of a major sovereign credit event."
London interbank offered rates for three-month dollars fell to 0.52722 percent from 0.52889 percent, but its premium over anticipated central bank rates - a key gauge of market stress - was still at its highest since mid-2009. In the forward foreign exchange market, the cost to European banks of swapping euros for one-month dollar loans was up on the week - with the euro/dollar basis at minus 124 basis points compared with 105.5 bps on Monday. Banks' inclination to hoard cash over year end exacerbated the moves, analysts said.
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