Interbank strains hit record

A key gauge of interbank strains hit its highest in a year on Thursday as banks grew more reluctant to lend dollars to European counterparts after euro zone leaders failed to convince markets they have contained the bloc's debt crisis. A Franco-German proposal for economic governance and eurozone integration this week did little to soothe investor concerns that the debt crisis will continue to spread as the immediate problem of funding for weaker countries remains unresolved, analysts said.
"(Markets) are concerned about a potential intensification of financial stress," said Philip Tyson, strategist at MF Global. The three-month US dollar Libor/OIS spread - a measure of counterparty risk - hit its highest level in a year at 19 basis points. London interbank offered rates for three-month dollars continued their upward march, to hit fresh highs since April at 0.29778 percent from 0.29589 percent on Wednesday.
Highlighting tensions, the Wall Street Journal reported that the Federal Reserve Bank in New York was taking a closer look at the US units of Europe's biggest banks, out of concern the eurozone debt crisis could spill into the US banking system. But William Dudley, the New York Fed Bank's president, said the institution was "always scrutinising" banks and that it treated US and European banks "exactly the same".
Matteo Regesta, rate strategist at BNP Paribas, said that would be a natural reaction from regulators after the European Central Bank saw demand for seven-day dollar loans for the first time in almost six months on Tuesday. The spread between three month Eonia and three month Euribor - a proxy between collateralised and uncollateralised lending in the interbank market and an indicator of strains - fixed up at 65 basis points, compared with a year-to-date average of 28 bps.
French and German leaders disappointed financial markets this week, signalling that a common sovereign bond, if it ever comes, would be a long way off and that instead they were focusing on more policy integration. But a Reuters poll of economists taken this week suggests Europe's power brokers will have to face up to the reality that jointly-issued debt might be one of the few measures that can stem the sovereign debt crisis, which threatens to overwhelm some of the bloc's biggest economies. Tyson said financial stress was going to be a persistent problem until there were more concrete solutions to the crisis - ultimately more integration and common bond issuance.