Oct. 8 (Bloomberg) -- The cost of borrowing in dollars overnight in London soared for a third day before central banks around the world lowered interest rates in a joint effort to restore confidence to the global financial system.

The London interbank offered rate, or Libor, that banks charge for such loans jumped 144 basis points to 5.38 percent today, the British Bankers' Association said. It was the second day the rate rose more than 100 basis points. The rate was 2 percent on Oct. 3. The one-week dollar rate climbed 35 basis points to 4.52 percent, the highest level since December. The Libor-OIS spread, a gauge of cash scarcity among banks, widened to a record.

``This smells like panic to me,'' said Marius Daheim, a senior bond strategist in Munich at Bayerische Landesbank, Germany's second-biggest state-owned bank. ``We don't think this is going to do the trick with freeing up liquidity in the money markets. Banks will still hoard liquidity to meet future funding needs and rate cuts aren't going to do anything about that.''

Interbank lending rates have soared as financial institutions store cash to meet anticipated funding needs, defying the efforts of central banks to revive the frozen credit markets. The Federal Reserve said it cut the target rate for overnight loans by a half point to 1.5 percent today. The central banks of the euro region, the U.K., Canada, Sweden, Switzerland and China also reduced rates.

The overnight euro rate dropped to between 3.8 percent and 4.3 percent after the central banks' announcement, according to Jan Misch, a money-market trader at Landesbank Baden- Wuerttemberg. The rate was fixed at 4.35 percent earlier.

Coordinated Action

``The recent intensification of the financial crisis has augmented the downside risks to growth and thus has diminished further the upside risks to price stability,'' the central banks said in a joint statement. ``Some easing of global monetary conditions is therefore warranted.''

The U.K. said earlier it plans to invest about 50 billion pounds ($87 billion) in an unprecedented step to stave off a collapse of the country's banking system.

The deepening credit crisis forced the U.K. to join the U.S., Ireland, Iceland, Belgium and Spain in rushing out untested bailout measures to save banks. As part of the plan, Prime Minister Gordon Brown's government will buy preference shares, and the Bank of England will make at least 200 billion pounds available for banks to borrow under a so-called special liquidity plan, the Treasury said today in a statement.

Barclays Plc and Royal Bank of Scotland Group Plc, the U.K.'s second- and third-biggest banks, said they plan to participate in the government rescue.

Dollar Bids

The Frankfurt-based ECB said today it provided banks with $70 billion of one-day loans, up from $50 billion yesterday. Banks bid for $122 billion. The 9.5 percent marginal rate at which 96 percent of the funds were borrowed compares with today's Libor of 5.38 percent and the Federal Reserve's target rate of 1.5 percent.

The Libor-OIS spread, which measures the difference between the three-month dollar rate and the overnight indexed swap rate, increased to 324 basis points today. It was at 167 basis points two weeks ago and 81 basis points a month ago.

The yield on three-month U.S. bills slid 15 basis points to 0.61 percent, signaling investors still sought the safest government securities. They touched 0.02 percent on Sept. 17, the lowest since the start of World War II.

TED Spread

Libor, set by 16 banks in a daily survey by the British Bankers' Association at about noon in London, determines rates on $360 trillion of financial products worldwide, from home loans to derivatives. Member banks provide estimates on how much it would cost to borrow in 10 currencies for periods ranging from a day to a year. Euribor, set in a survey of more than 30 institutions by the European Banking Federation, is published about 90 minutes earlier.

President George W. Bush signed a $700 billion U.S. bailout bill into law last week to help stem the crisis, which has claimed financial companies including Bear Stearns Cos. and Lehman Brothers Holdings Inc. The legislation enables the government to purchase tainted assets from institutions. European leaders meeting in Paris over the weekend pledged to bail out their own nations' banks, while stopping short of a regional rescue effort.

The difference between what banks and the Treasury pay to borrow money for three months, the so-called TED spread, was at 391 basis points. Earlier, it widened to 402 basis points, the most since Bloomberg began compiling the data in 1984.

Writedowns and losses worldwide tied to the U.S. mortgage market have reached $593 billion since the start of last year, according to data compiled by Bloomberg.

To contact the reporter on this story: Gavin Finch in London at gfinch@bloomberg.net

Last Updated: October 8, 2008 11:27 EDT