The credit crunch hit the worst point in its 13-month history today as Europe's major banks effectively stopped lending dollars to each other.

The rate banks charge each other for borrowing money jumped to levels not seen since the start of the credit crunch in August 2007. The sharpest rise in overnight lending rates came in the dollar, where it more than doubled from 3.10625% to 6.43750% — its highest for seven years. That is more than three times the official US interest rate of 2%, which many analysts were expecting would be cut to 1.75% at this afternoon's meeting of the Federal Reserve.

The last time the dollar overnight rate, which is fixed in London by the British Bankers Association, stood anywhere near this level was in January 2001 when the official US interest rate was 6%.

Traders said the squeeze on dollar funds reflected a lack of dollars in the markets during European trading hours as banks held on to their greenbacks in case they were forced to settle deals following the collapse of Lehman Brothers.
“This is much worse than August last year,” said one market insider.

Another said: “European banks can't get dollars. Banks are hoarding cash in case they have payment issues particularly with Lehman.”

All the major European central banks were lending more support to the money markets today. The Bank of England offered another £20 billion of what it called fine-tuning to the money markets, and received bids for almost three times that amount.

The Bank yesterday offered just £5 billion of short-term liquidity. The European Central Bank pumped €70 billion into the money markets, up from €30 billion on Monday. The Swiss National Bank injected Swfr8 billion of liquidity.

Dealers warned this was not helping the main problem, which is the lack of dollars in the market. But that did not stop sterling Libor jumping from 5.49375% to 6.79375%.

Shares in UK and European banks slumped on fears that their ability to fund business will be severely curtailed, while they may have as-yet-unrevealed exposure to Lehman.