(REUTERS) - 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 euro zone leaders meet on Dec. 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 U.S. money market funds and financial institutions scaled back short-term loans to them fearing some banks' exposure to bad debt from struggling euro zone 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.
Wednesday's move by the U.S. Federal Reserve, the European Central Bank and other top central banks to lower the cost of existing dollar swap lines by half a percentage point has driven interbank costs off their worst levels.
But some gauges of money market strain stayed near end-2008 levels with analysts saying a return to more normal interbank lending required a substantive solution to the debt crisis.
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.
The premium to European banks of swapping euros for three-month dollars as reflected by closely watched euro-dollar basis swap rates fell to one-week lows but was far from cheaper levels seen in April.
The lower price for central bank money should encourage European banks to borrow more dollars from the ECB at its three-month tender next week, although the stigma associated with the use of the facility may prevail.
It is not only the cost of these swap lines that has acted as a deterrent but the signal of distress their usage implies - yesterday's price cut doing nothing to address the latter, said Rabobank strategist Richard McGuire.
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.
The turn of year is a real concern for those euro zone institutions seeking dollar funding but, despite a significant reaction to yesterday's coordinated policy move, euro/dollar basis remains at levels that are indicative of rather extreme underlying stress, ICAP analyst Chris Clark said.
Next week's one-week and three-month ECB dollar tenders look like they may well release a good deal of pent-up demand, after which basis could be expected to fall back towards less extreme levels.