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Short-term dollar funding rates edge up on U.S. debt caution

By Emelia Sithole-Matarise

LONDON, Oct 14 (Reuters) - European banks' very short-dated dollar borrowing costs edged up on Monday as the U.S. debt talks impasse continued, but rates stayed within last week's ranges as investors believe a deal will be reached.

U.S. debt markets were closed for the Columbus Day holiday but the cost of insuring against a default by the world's biggest economy rose in Europe after Democrats and Republics failed to agree on raising the government's borrowing limit.

Offshore dollar demand around the world rose last week as banks sought to tide themselves over a potential liquidity crunch on or around Oct. 17, when the United States is expected to hit its borrowing limit.

There has been no sign of strain in the market so far, with short-term dollar rates way below the panic levels seen two years ago when U.S. money market funds cut lending to European banks at the height of the euro zone debt crisis.

Still, markets are watching the European Central Bank's dollar tender on Wednesday more closely than ever for signs of any impact from the U.S. situation.

Friday's expectations that a deal could be reached over the weekend were quashed on Saturday, although Senate leaders said on Sunday they were optimistic a deal would be reached in time.

Concern has been most evident in the U.S. Treasury market, where very near-term T-bill rates have risen and the forward exchange markets where non-U.S. banks and investors typically pay a premium to raise dollars.

One-week euro/dollar basis swap rates edged up to minus 7.75 basis points from minus 6.5 basis points on Friday, meaning the premium charged to swap euros into dollars has risen. The two-week premium was also slightly up at minus 22.75 basis points, according to prices provided by broker ICAP.

The benchmark three-month rate, was steady on the day at minus 9 bps, back to the high negative single digits that prevailed early last week before U.S. debt concerns rattled markets.

This was still less than half the minus 25 bps seen at the end of last year and minus 167.50 in November 2011 at the height of a previous wave in the euro zone crisis before massive three-year European Central Bank cash injections cooled the situation.

"There are some signs of concern but markets seem to be remarkably relaxed, especially in the spot FX market, and there still seems to be some sort of assumption that a deal will be agreed before that debt ceiling is hit," said Tom Levinson, a foreign exchange strategist at ING.


Markets are keenly awaiting the ECB's dollar tender on Wednesday for any signs of strain.

Banks' appetite at these tenders has been marginal over the past year as their access to U.S. money market funds improved as concerns about the euro zone debt crisis eased.

Last week, the take-up for 3-month dollar funding was only $112.8 million, and demand for one-week funds was zero. The last time banks borrowed over $1 billion was on May 22, when they took up $1.293 billion of three-month cash.

"What we are seeing is a period where institutions are incentivised to hold on to any liquidity they have and borrowing rates have risen, but this is comparable to year-end effects and not any of the big disasters we have seen before," said ICAP strategist Chris Clark.