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BLBG: Dollar Rises Against Euro on Demand for U.S. Currency Funding
 
By Ye Xie and Kim-Mai Cutler

Oct. 1 (Bloomberg) -- The dollar advanced against the euro for a third day as demand for funding in the U.S. currency increased, reflecting banks' reluctance to lend to each other amid a global credit crunch.

Foreign banks are paying near the highest premiums in at least a decade to borrow in dollars in the swaps market even after the Federal Reserve increased the amount of funds available to other central banks this week to $620 billion from $330 billion. The U.S. Senate set a vote for tonight on a $700 billion financial-rescue plan.

``Markets need dollars,'' said Matthew Kassel, director of proprietary trading at ING Financial Markets LLC in New York. ``They need funding, and they buy dollars in the spot market.''

The dollar advanced 0.6 percent to $1.4014 per euro at 10:09 a.m. in New York, from $1.4092 yesterday. It touched $1.3882 on Sept. 11, the strongest level in a year. The dollar fell 0.5 percent to 105.58 yen, from 106.11. The euro dropped 1.1 percent to 147.89 yen, from 149.56.

Britain's pound declined to the lowest level against the dollar in almost three weeks after an industry report showed U.K. manufacturing contracted last month at its fastest pace in 16 years. Sterling fell as much as 0.8 percent to $1.7655, the lowest level since Sept. 12. Against the euro, the pound decreased 0.2 percent to 79.29 pence.

Rising Libor

The London interbank offered rate, or Libor, that banks charge each other for one-month dollar loans rose to the highest level since January, the British Bankers' Association said. The overnight dollar Libor slid from yesterday's record of 6.88 percent after funding constraints tied to the end of the third quarter passed. The Libor-OIS spread, a gauge of cash scarcity, held near a record.

``Because the money market is not working, you know that non-U.S. banks have a huge dollar funding position globally,'' said Hans Guenter Redeker, the London-based global head of currency strategy at BNP Paribas SA, France's biggest bank. ``As they're forced to cut balance sheets, they are buying dollars to pay back loans.''

The price on one-year cross-currency basis swaps between euros and dollars reached minus 120 basis points today, the largest effective premium for dollar borrowing in swaps since the euro's 1999 debut, according to data complied by Bloomberg. The price averaged close to zero from 1999 and the start of the subprime mortgage market collapse in August 2007.

A negative swap price indicates investors are willing to receive reduced interest payments on the euro they lend to obtain the needed financing in dollars.

Currency Swaps

Cross-currency basis swaps are agreements in which a trader borrows in one currency and simultaneously lends in a different currency. The transaction involves the exchange of two different floating-rate payments, each denominated in a different currency and based on a different index.

The dollar fell against the yen as the Institute for Supply Management's factory index dropped last month to 43.5, the lowest since October 2001, from 49.9 in August, the Tempe, Arizona-based group reported today. A reading of 50 is the dividing line between expansion and contraction.

The U.S. Senate agreed to vote on the rescue legislation along with the measure temporarily raising the limit on federal deposit insurance to $250,000 from $100,000. That increase was proposed by Republicans critical of the plan authorizing Treasury Secretary Henry Paulson to buy troubled debt from lenders, which was rejected by the House on Sept. 29.

The euro's drop versus the dollar came a day before a meeting of the European Central Bank at which policy makers led by Jean-Claude Trichet are forecast to keep the main refinancing rate at 4.25 percent.

``I don't think the euro can get a lot of traction out of Trichet tomorrow,'' said Jeremy Stretch, a strategist in London at Rabobank International, the third-largest Dutch bank. ``If he is seen to be hawkish, the euro will fall, and if he is seen to open the gates, I think the euro will slide on that basis.''

To contact the reporters on this story: Ye Xie in New York at yxie6@bloomberg.net; Kim-Mai Cutler in London at kcutler@bloomberg.net

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