Wednesday, 15 October 2008

Bank of England rate cuts completely ineffective

The Bank of England cut interest rates by 50 basis points last week, and it had absolutely no effect whatsoever on the three-month sterling interbank interest rate. Actually, while the Bank of England was cutting, interbank rates were rising. As things stand, it appears that Bank of England has lost control of interest rates.

Again, today central banks are pumping out extraordinary amounts of liquidity into the financial markets. The financial Times reported that across Europe more than $250 billion was injected.

Thins are not any better across the channel. The ECB relaxed its criteria for the collateral, lowering the credit rating threashold for accepting assets to BBB- from A-. It also said it would accept assets denominated in foreign currencies and debt instruments issued by credit institutions. In other words, the ECB is now accepting any old rubbish as collateral.

The breakdown of the interbank market is most acute with longer maturities. The overnight dollar LIBOR rate is down to 2.14 percent. At the same time, three-month dollar Libor rate is hovering around the 4.5 per cent level.

Even with all the recent announcements to recapitalise the banks, guarantee deposits, and underwrite the interbank market, banks are still unwilling to lend to each other anything longer than a few days.

It could take a long time before things returned to normal.


Josh said...

What will it take for things to return to normal?

Anonymous said...

The BoE's inablity to influence the interbank rate is a very good thing.

With inflation at 5% or more, savers deserve the chance to at least hold the value of their savings against inflation.

Even then, the Chancellor may make more out of their savings through taxation of their interest than savers do. But at least he is guaranteeing their deposits... justice?

B. in C.

dearieme said...

It's a blow for those savers whose accounts pay interest at a rate linked to the BoE base rate. Thanks, Gordo!

Nick von Mises said...

"What will it take for things to return to normal?"

Define normal. If you think May 2007 is normal consider yourself lucky you found this blog before you did yourself an injury.

MAB said...


It could take a long time before things returned to normal.

I agree. We are no where close to the end of the de-leveraging.

All asset classes are still over-valued on a historical basis. The fallacy that asset prices can now trade at a premium to histoical valuations due to stability has been shattered. Splattered all over Manhattan (I borrowed that that from a Brit - Mick Jagger). As leverage is unwound and risk premiums are increased, asset prices will return to long term trends. And they may overshoot.

It's a process. A painful one for many.