The Bank of England's latest special auction of three-month funding received the biggest demand yet as banks lined up for a liquidity injection amid panicky financial markets.
Demand for the £10bn of funding was the highest of the three auctions that the Bank has held since central banks around the world first announced co-ordinated action in November to try to ease inter-bank lending rates. Yesterday's operation received bids worth £16.93bn, compared with £13.13bn in January and £10.85bn in December.
Central banks are trying to encourage institutions to lend to each other in order to unglue the money markets, which have been paralysed by fears about banks' liquidity. But the auction could not prevent sterling three-month Libor, the rate at which banks lend to each other, rising to 5.9725 per cent from 5.95875 per cent the previous day.
An industry source said the auction was helpful, but was "pretty modest" given the current conditions in credit markets. The money is not offered cheaply and requires high-quality collateral, the source pointed out.
Analysts said the demand for longer-dated money suggested the Bank of England should make more of the funds available at its April auction. The Bank has said it will review the amount of three-month funds it offers at its April auction in light of yesterday's operation.
The Bank of England's main aim is to keep the overnight inter-bank rate close to base rate. The central bank injected £5bn of liquidity on Monday in an exceptional "fine-tuning" operation to try to ease a spike in inter-bank overnight rates.
The sterling overnight Libor rate was at 5.58125 per cent yesterday, down from 5.5875 per cent on Monday but still significantly higher than desired compared with the Bank's base rate of 5.25 per cent.
The auction was part of a concerted effort by the Bank, the US Federal Reserve and other central banks to inject liquidity and confidence into financial markets that have been shocked by the near-collapse of Bear Stearns, the US investment bank.
In an unusual move, Mervyn King, the Governor of the Bank of England, postponed a trip to the west Midlands yesterday "because he needs to be in London to monitor events", the Bank said. Mr King had been due to meet business leaders and visit one or two companies in the region. Mr King makes about 12 of the trips each year to find out what is going on in different regions of the country.
Banking stocks staged a partial recovery yesterday after the battering they took on Monday in the wake of the fire sale of Bear Stearns to JPMorgan. The big-gest gainer was Alliance & Leicester, which rose 8.4 per cent, with Royal Bank of Scotland, HBOS and Barclays all rising by more than 4 per cent.
The shares rose partly because of better-than-expected results by Lehman Brothers and Goldman Sachs in the US. Both investment banks reported sharp falls in first-quarter profits on writedowns of mortgage-backed securities and leveraged loans, but investors greeted the results with relief after the panic of recent days.
Lehman, which has been the focus of investor fears after the downfall of Bear Stearns, said it had "a robust liquidity pool" of $34bn at the end of the quarter.
Markets went into panic after Bear Stearns agreed to be sold to JPMorgan for $236m (£117m), a fraction of its book value. The bank insisted last week that it was in good health, but fears among counterparties became self-fulfilling when lines of credit were pulled, pushing the bank towards insolvency.
Expectations of a significant interest rate reduction from the US Federal Reserve also boosted banking shares. While the 0.75 percentage point cut delivered last night after the UK market had closed was lower than some economists had predicted, financial stocks in the US did not give up their earlier gains.