Key dollar rate climbs

The bank-to-bank cost of borrowing dollars for three months rose on Wednesday to its highest level since May as an escalation in the eurozone debt crisis prompted investors to ask for a higher premium to lend in interbank markets. A key indicator of counterparty risks hovered near two-year highs as fresh signs of contagion added to concerns that the eurozone crisis may be entering a more dangerous phase where core economies come into the firing line.
The yield spread between 10-year Belgian and German bonds hit a euro life-time high, while Italian borrowing costs look set to overtake Spain's in coming weeks as July's euro zone deal failed to draw a line under the region's woes. "A lot of what we are seeing is driven by the demand for dollars of the European banks," said Simon Peck, rate strategist at RBS. "It all ties in to the story of funding stress, which has been elevated at a time of increased systemic risk concern, which we are seeing now."
The 3-month dollar Libor rate - a key interbank rate for borrowing dollars - fixed at 0.26828 percent, up from 0.26444 percent on Tuesday. The euro/dollar one-year cross currency basis swap, which widens when lenders charge more for swapping euro interest payments on an underlying asset into dollars, hovered around its widest levels since January.
With the possibility of an immediate US default out of the way, analysts are now looking at developments in the eurozone, where the crisis seemed to be spreading beyond peripheral countries. Eurozone leaders tried to ring-fence the debt problems in July when they announced a second rescue plan for Greece and gave the eurozone rescue fund more power.
Instead, yields on Spanish and Italian bonds held firmly above 6 percent levels, and now even core eurozone economies are feeling the pressure. Along with Belgian spreads, the French/German 10-year government bond yield gap hit fresh euro-era highs earlier. The equivalent dollar Libor/OIS spread was fixed at 14 basis points, 3 basis points wider on the day. The bank is almost certain to keep interest rates on hold this month after raising them to 1.5 percent in July, and Eonia forwards are not pricing in any hikes until next year, analysts said.