Bank-to-bank lending rates dip again, a day after the U.S. government unveils its plan to buy equity in banks.

By Catherine Clifford, CNNMoney.com staff writer

The credit markets continued to show signs of relief Wednesday, a day after the U.S. government announced plans to inject capital directly into banks by buying their stock.

The overnight bank-to-bank lending rate slid, with the London interbank overnight rate (Libor) slipping to 2.14% from 2.18%Tuesday, according to Bloomberg.com. The measure had been as high as 5.09% last Thursday.

Lower interbank lending rates signal a an increased willingness on the part of banks to lend to each other, which eventually translates into lower borrowing costs for consumers.

Frozen credit pipelines had stalled economies around the world, pushing lawmakers to make global coordinated efforts to increase liquidity in and give banks the confidence to begin lending to each other again.

Lending rates: The 3-month Libor continued its descent Tuesday, ticking lower to 4.55% from 4.64% the previous day, according to Bloomberg.com. The measure remains at elevated levesl. It had surged to 4.82% Friday - the highest since mid-December 2007. By comparison, it was only 2.82% a month ago.

Libor is a daily average of what 16 different banks charge other banks to lend money in London and is used to calculate adjustable rate mortgages. The higher the rate, the tougher it could be for homeowners to pay those mortgages. Libor is also used to calculate other types of loans, including student and auto.

The dips signal some loosening of the tight credit hold, but there still a long way to go before cash flows freely, said Kenneth Naehu, managing director and head of fixed income at Bel Air Investment Advisors.

Rumblings of risk aversion remain: Two market gauges show that investors continue to be wary.

For example, the "TED spread" edged up to 4.32%, after moving between 4.30% and 4.09% Tuesday.

The TED spread measures the difference between the 3-month Libor and the 3-month Treasury bill, and is a key indicator of risk. The higher the spread, the more unwilling investors are to take risks.

The spread was 1.04% just a little over a month ago and had reached a record high of 4.65% on Friday.

Another indicator, the Libor-OIS spread, rose to 3.44% from 3.39% Tuesday, after touching a record high 3.67% Friday. The Libor-OIS spread measures how much cash is available for lending between banks, and is used for determining lending rates. The bigger the spread, the less cash is available for lending.

Treasurys: Government bond prices were mixed Wednesday as investors looked for a short-term safe haven, but shied away from longer-term investments after a government report showed a key measure of inflationary pressure ticked higher.

The Labor Department's Producer Price Index showed that the core rate, which exclude volatile food and energy costs, rose by 0.4%. That was twice as high as analysts had expected.

"That was very bad on the broad front [and] indicates that inflation will at least for a little be worse than before," said Pierre Ellis, senior economist at Decision Economics.

That will keep downward pressure on longer-term bond prices because investors quickly become wary about tying up assets in long-term investments if there is a chance inflation will intensify.

The 30-year bond fell 8/32 to 103-15/32 while the yield increased to 4.29% from 4.27%.

The benchmark 10-year note was up 3/32 to 99-14/32 while its yield was 4.07%. Bond prices and yields move in opposite directions.

The 2-year note ticked up 5/32 to 100-16/32 and its yield dipped to 1.75% from 1.81%.

3-month bill: The yield on the 3-month Treasury bill is closely watched as an immediate reading on investor confidence. Investors and money-market funds shuffle funds into and out of the 3-month Treasury bill frequently, as they assess risk in the rest of the marketplace.

The yield on the 3-month bill to a low of 0.18% before rallying to 0.23% Wednesday - little changed from Tuesday's late-day yield of 0.27%.

"At the shorter maturity, the prices are reflecting great desire for security," said Ellis.

And Naehu added that investors are "parking money" until they see the succesful implementation of the government's bailout.

After the stock market's 936-point rally on Monday, investors dumped Treasurys in favor of the more profitable equity markets. However, after watching Wall Street's more tepid performance Tuesday, with the Dow closing down 76 points, investors returned to the bond market.

Government debt is considered by investors to be among the safest assets. In times of uncertainty, demand for Treasurys increase, sending prices higher.

Fed moves: On Tuesday, the government announced that the Treasury will buy up to $250 billion in senior preferred shares in a variety of banks, and so far, nine banks have agreed to have the government take a stake. In addition, the Federal Deposit Insurance Corp. will temporarily provide unlimited coverage for all non-interest-bearing accounts.

"The goal of these policy actions is to diminish the perceptions of risk by boosting the capital of banks and ensuring the funding of banks is going to be reasonably stable," said Ellis.

Despite a slew of historic and extraordinary moves, however, it could take a while for the economy to return to health. "It is a little premature to gauge success because they have just begun to start to implement" all of the plans that have been announced, said Naehu. "The market has a sort of wait-and-see feel to it," he said.

The broader questions that lenders have about the health of the economy are "not going to be answered by a plan being in place," added Naehu. Those uncertainties will finally "be answered by implementation and the effects that the implementation has on the credit markets."

Source: CNN Money