FED FOCUS-With credit still tight, Fed mulls liquidity tools

By Mark Felsenthal

WASHINGTON, April 25 (Reuters) - As the U.S. Federal Reserve hones in on the end of its interest-rate cutting campaign, officials remain troubled by lingering stress in credit markets and continue to mull steps to ease the strain.

The Fed has been waging a two-front battle against a credit crunch that has paralyzed financial markets and put a strait-jacket around the economy. It has cut rates sharply and has offered a menu of options for commercial and investment banks to obtain the credit they can't find in the open market.

Now, officials suggest that after a rate-cutting spree that has taken benchmark borrowing costs to 2.25 percent from 5.25 percent since mid-September, they may soon step to the sidelines to see if the rate reductions and a government stimulus package that will put billions of dollars into consumers' pockets have their intended curative effect.

When it wraps up a two-day meeting on Wednesday, the Fed is expected to lower rates by a slim quarter-percentage point, a move financial markets believe will be the last in the cycle.

However, Fed officials see persistently shaky conditions in short-term funding markets and signs financial institutions are still in a defensive crouch, and continue to explore whether further actions to ease liquidity strains would be helpful.

Any further steps may draw on the experience of other central banks, which have offered financial institutions funding for longer durations. In addition, the Fed could decide to expand currency swap lines with other central banks.

A key indicator of short-term lending, the gap between the three-month London Interbank Offered Rate, or Libor, a gauge of what banks charge each other for loans, and overnight indexed swaps, a measure of anticipated benchmark interest rates, remains elevated and has raised concerns at the Fed.

"Gyrations in the spread between Libor and the overnight index swap rate ... demonstrate that we continue to have episodes where the spreads become large by historical standards," Boston Federal Reserve Bank President Eric Rosengren said last week.