THE cost of dollar deposits eased sharply in Asia on Tuesday alongside other signs that the fear of bank-to-bank lending was abating after governments around the world rushed out plans to bolster their banks.

From swap spreads in Australia to China's declining short-term rates, risk measures in money markets softened as banks drew comfort from plans by governments in the United States and Europe to take up stakes in their big banks.

Front-end eurodollar futures also rallied for a second day, indicating that the market expects interbank dollar costs to decline further.

'The overall expectation is that LIBOR is coming down,' says Mr Joseph Kraft, head of Japan capital markets at Dresdner Kleinwort.

Traders in Singapore said overnight dollar deposits were quoted between 2 and 3 per cent. 'Most trades are taking place at 2.5 per cent,' one trader said. That is slightly above the Federal Reserve's 1.5 per cent target but far below the 10 per cent peak seen at the height of the financial upheaval that followed the collapse of Wall Street investment bank US bank Lehman Brothers.

US markets were closed on Monday, but one-day funds traded at 3.5-4.5 per cent in deals settled on Tuesday/Wednesday in Asia on Monday.

Stock markets across Asia also rallied, spurred by the biggest one-day gain in Wall Street's benchmarks after reports that Washington was ready to pump $250 billion into US banks and European governments announced similar massive support for their lenders.

Analysts at Goldman Sachs said the announcement of unlimited swap lines between the Federal Reserve and other major central banks would go a long way in relieving pressures in the dollar funding market, one that has been hardest hit by the credit crisis.

In Australia, the swap spread narrowed sharply in a reflection of fears easing in the credit market. The one-year spread between swaps and bond yields, a measure of risk, dropped to 89 basis points from 158 late last week.

China's weighted average seven-day bond repurchase rate, a key funding rate, fell sharply to 3.1536 per cent, its lowest level since late September, from Monday's close of 3.3292 per cent.

The eurodollar December futures were up 17 basis points to imply a 3-month London Interbank Offered Rate of 2.585 per cent while March 2009 contract was up 11 basis points to imply a LIBOR of 2.21 per cent.

The dollar 3-month LIBOR was set 6.6 basis points lower on Monday at 4.7525 per cent in the first sign that the array of planned capital injections into the global banking system was improving confidence in money markets.

The spread between 3-month LIBOR and 3-month interest rate swaps also shrank slightly to 361 basis points after jumping from near 100 basis points following the Lehman bankruptcy. -- REUTERS