The Bank of England compiles its very own hit parade; the top ten data downloads. The number one spot is currently held by the the daily sterling LIBOR/LIBID interbank lending rate. The second most popular download is the official bank rate. Put them together and we get the 3 month LIBOR/LIBID interbank spread.
Why is there such interest in sterling LIBOR? Or for that matter, why is anyone even interested in the interbank market? Presumably, banks have sophisticated funding mechanisms for their balance sheets. Is the interbank market really that important?
Back in the days before the credit crunch, the interbank market played only a small part in funding commercial bank activity. It was the chump change that banks held at the end of a day's operations. Banks lent this spare change only as a afterthought. Lending volumes behind this market were low and the returns were minimal.
LIBOR is more of a benchmark than a market price. All kinds of weird and wonderful derivatives are priced using LIBOR. Variable rate loans have their interest rates determined by LIBOR. So, with the LIBOR rate now jumping around, the disruption goes further than just the interbank trade in excess liquiidity.
However, LIBOR is even more important than that. It is the vital link between the Bank of England's official rate and the interest rates that the real economy face when lending or borrowing. When the MPC change monetary policy, LIBOR is supposed to follow. Since so many other interest rates feed off LIBOR, credit conditions throughout the economy should also be affected. In other words, LIBOR is the messenger boy for monetary policy.
So that chart above tells us much more than the current state of trust between UK banks. It tells us that monetary policy is broken. The Bank of England no longer control interest rates. LIBOR is floating around aimlessly, and despite the best efforts of the BoE, it remains unstable. As if to prove the point, last week the Bank of England cut rates, but LIBOR just kept on jumping around.
So there is no point calling for more rate cuts. The official rate has lost its vital link to the rest of the world. If the Bank of England is to regain control of monetary conditions, the banks need to be fixed, and LIBOR needs to start acting in a predictable manner.