Banks today faced a 10-year high on the cost of borrowing money as jitters over liquidity in the UK market increased institutions’ reluctance to lend funds to each other.

The London interbank offered rate (Libor) for three-month sterling rose to 6.79 per cent, which is the highest level since late 1998 when the collapse of the hedge fund Long Term Capital Management ignited fears of a worldwide financial crisis.

Market volatility took another scalp today when it emerged that Synapse Investment Management, the London-based hedge fund manager, has been forced to close a fixed-income fund because of “severe illiquidity” in the market.

Synapse High Grade ABS, the affected fund, had “no exposure’’ to the US sub-prime mortgage market or “any other securities whose collateral has recently experienced any underperformance’’, the group said on its website. It fell of the current market climate, in which investors have dumped complex securities.

Libor is continuing to climb ahead of the Bank of England Monetary Policy Committee's much anticipated interest rate decision on Thursday.

The current interest rate of 5.75 – more than a full percentage point below Libor – is expected to stay the same after five increases since August last year.

The Bank of England’s Governor, Mervyn King, is facing rising pressure to act or explain its decision not to emulate the European Central Bank and America’s Federal Reserves who have been pumped billions of pounds worth of money into their respective central banking systems to ease liquidity.

There is still a lot of uncertainty in the banking sector about individual company exposure to US sub-prime mortgages – home loans awarded to people with a poor credit history.

Following a collapse in the US sub-prime mortgage market, there are concerns that banks may be nursing millions of pounds worth of losses through investments in financial instruments that include sub-prime mortgage assets.

Today Alliance & Leicester became the first UK bank to give a comprehensive breakdown of its investments that include sub-prime mortgage instruments.

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