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By Richard Leong
NEW YORK, Oct 29 (Reuters) - The increase in a key gauge of interbank borrowing costs for dollars slowed on Monday, while another measure of what banks borrow from each other remained elevated, raising speculation on what steps the Federal Reserve would take.
The London interbank offered rate for banks to borrow three-month dollars from each other rose 0.6 basis point to 2.52663 percent, the highest since October 2008. This followed a 1.1 basis-point rise on Friday.
LIBOR is the rate benchmark for $200 trillion of dollar-denominated financial products, mainly interest rate swaps and floating-rate loans.
The “effective,” or average, federal funds rate, what banks charge each other to borrow excess reserves overnight , held at 2.20 percent on Friday for a fourth straight day.
The effective fed funds rate and the interest the Fed pays banks on excess reserves they leave with the U.S. central bank (IOER) stayed at parity.
Some analysts have raised concerns if the average fed funds rate breaks above IOER, the Fed would be seen losing its grip on controlling short-term borrowing costs.
Analysts have blamed the elevated costs for fed funds on reduced supply of excess bank reserves due to heavy supply of Treasuries and the Fed’s reduction of its balance sheet.
If the effective fed funds rate were to drift higher, they expected the U.S. central bank could narrow the spread between the IOER and the lower end of its target range in an effort to make it less profitable for banks to leave their excess reserves at the Fed.
Fed policymakers embarked on tightening this spread back in June when they raised its target range on short-term rates by 0.25 point but increased the IOER by only 0.20 point.
Currently, the Fed’s target range on short-term rates is 2.00-2.25 percent, while the IOER is 2.20 percent.
Now that IOER and the effective fed funds rate reached parity, expectations have grown that Fed would tweak the IOER at its Dec. 18-19 meeting.
“The Fed will likely make another technical adjustment to IOER in December as the market expects, although we anticipate that pressure on the effective fed funds rate is likely to continue,” BMO Capital Markets analysts wrote in a report published late on Friday.
Interest rate futures implied traders expected about 75 percent chance the Fed would increase its target rate range on short-term rates by a quarter point next month.
Reporting by Richard Leong; Editing by Steve Orlofsky