By Jamie McGeever

So-called "term" funding of one month and beyond remains mostly expensive and scarce because banks prefer to hoard cash to bolster battered balance sheets rather than lend to counterparties they fear may be in severe financial distress.

The British Bankers Association's fixing of three-month dollar London interbank offered rates (Libor) was fixed at 4.33375 percent, the highest since early January.

The premium to borrow at Libor over anticipated policy rates, as measured by average Overnight Index Swap rates, blew out further to around 290 basis points, also a historic high.

But overnight dollar Libor tumbled almost 70 basis points to 1.99625 percent, the lowest in almost four years. That's even more remarkable, given the Federal Reserve's overnight target rate is 2 percent. There would usually be a credit premium built into Libor rates.

It suggests central banks' pumping billions of dollars of short-term dollar funds into the banking system, together with the passing of the quarter end this week, has succeeded in bringing overnight bank-to-bank lending rates down.

The European Central Bank and Bank of England joined monetary authorities in Asia in providing financial institutions with a plentiful supply of short-term liquidity on Friday. The ECB and BoE also eased rules governing liquidity provisions.

But ahead of the expected House of Representatives vote later in the day on the rescue package, money market nerves remained apparent.

"Developments on the legislative front have not been able to ease credit conditions either in the U.S. or abroad," UBS strategists said on Friday.

"Institutions remain wary of lending to one another," they said, noting that three-month euro Libor fixed at a fresh record high and the three-month dollar Libor/OIS spread hit historic highs too.

VOTE ON TARP

The three-month dollar Libor/OIS spread was last around 290 basis points. That compares with around 80 basis points a month ago before Lehman Brothers collapsed and in the years before the financial crisis broke in August last year it had flatlined around 10 basis points.

The closely-watched TED spread, or the difference between market-based dollar deposit rates and three-month U.S. government borrowing rates, was at the upper end of a range between 350 and 460 basis points.

In the interest rates swaps market, the two-year dollar swaps spread was around 160 basis points, hovering near the 166 basis points record high struck late on Thursday in New York, Reuters charts indicated.

The passing of the U.S. financial rescue plan which could come later on Friday would help shore up confidence across financial markets and rein in these spreads.

"There's a big focus on spreads, but that's not as relevant for the economy as the level of rates. The more serious thing is the rationing of credit ... especially to the non-financial sector," said Ciaran O'Hagan, senior strategist at Societe Generale in Paris.

Credit strategists at BNP Paribas noted that approval of the so-called U.S. Troubled Asset Relief Program (TARP) will start to ease those strains, but only gradually.

"The TARP cleansing process will be slow, painful, and limited in scope, given the size of the fund relative to that of the problem. A more comprehensive solution addressing the real problem for banks, namely undercapitalization, will have to be put in place by the new administration," they said on Friday.

LIQUIDITY PROVISIONS

Massive central bank cash injections have helped keep trading going on an overnight basis since confidence collapsed with the demise of Lehman Brothers and subsequent rescue of several European banks.

Central banks around the world acted aggressively again on Friday.

In Asia the Bank of Japa.Wn (BOJ) injected 800 billion yen ($7.6 billion) in an over-the-weekend operation and Australia's central bank added A$1.57 billion ($1.2 billion) in repurchase agreements, way above an estimated daily need of A$1.195 billion.

In Europe, the BoE auctioned $10 billion overnight money and $30 billion of one-week cash. It also relaxed collateral rules for its weekly three-month auctions.

The ECB auctioned $50 billion of three-day funds, having drawn bids of over $82 billion, and threw open the doors for thousands of banks to access its so-called 'fine-tuning' operations for overnight auctions.

The ECB also said on Friday financial institutions upped their borrowing from and deposited another hefty amount at the central bank.

The ECB left its benchmark rate on hold at 4.25 percent on Thursday but highlighted the risk to the European economy from the credit crunch, suggesting the first euro zone rate cut in five years was on the cards.

Financial markets now expect a rate cut at the ECB's next meeting and a further two cuts to 3.50 percent by February.

In the United States, there was no relief for the commercial paper market. Outstanding paper slumped by $94.9 billion to $1.607 trillion, Federal Reserve data showed, bringing the cumulative shrinkage to $208 billion in the past three weeks.

Fed data also showed banks borrowed a record $367.8 billion from the central bank in the latest week.

(Additional reporting by Eric Burroughs and Yuzo Saeki in Tokyo, Kevin Yao in Singapore, Wayne Cole in Sydney, Alister Bull in Bloomington. Editing by Andy Bruce)