The Bank of England is continuing to reject the pleas of traders in the sterling money markets by declining to inject liquidity into the U.K. financial system.
And while market sources say this has led interbank borrowing and lending to "grind to a halt" in recent days, the BOE's inaction shows it doesn't yet see any threat to the stability of the financial system.
Moreover, analysts say, the rise in money market interest rates could help the BOE to achieve its main objective of taming U.K. economic growth and inflation, while aiding the re-pricing of risk and asset prices it's long warned is needed.
The interest rates banks charge each other to borrow sterling have risen sharply since credit fears began to permeate the market Aug. 9. But in contrast to the U.S. Federal Reserve, the European Central Bank and the Bank of Japan, the BOE has chosen not to lend freely to banks in an attempt to bring those rates down.
The London interbank offered rate has risen particularly quickly for lending of one month or more. The 1-month LIBOR rate had risen to 6.51% by Thursday this week from 5.94% two weeks ago, while the 3-month rate had risen to 6.62% from 6.1% over the same period. Both rates are considerably above the BOE's current target interest rate of 5.75%.
Even the rates quoted are to some extent guesswork, says one market participant who wished to remain anonymous.
"The sterling money markets have apparently ground to a halt in a way that the euro and dollar markets have not - banks are simply not lending any significant amounts of money, even to other banks, let alone non-financial corporations," he said. "In other words, de facto, there is no sterling LIBOR market - LIBOR rates quoted on screens are really 'plucked out of the air'."
Several market sources confirm that BOE officials, up to and including Executive Director for Markets Paul Tucker, have been in regular contact with trading floor heads, and have been made aware how gummed up the market has become.
"They've sounded out a whole range of market sources, but they're not prepared to act," says a source at one of the U.K.'s leading clearing banks who also wished to remain anonymous.
That suggests that the BOE's fundamental belief is that despite market participants' concerns, it's not yet necessary for them to do more than reassure financial institutions about the availability of its standing lending facility - a system by which banks needing funds can tap the Bank, albeit at a penalty rate of interest.
"The bottom line is that there hasn't been a major failure in U.K. money markets: if there were to be one, the BOE would of course step in," said Julian Jessop, chief international economist at Capital Economics in London.
The Bank of England declined to comment on claims that the money markets had ground to a halt, and suggestions that its officials have had extensive contacts with market participants.
The rise in the cost of interbank borrowing could also have some happy side effects for the BOE in terms of its broader policy objectives.
While the rise in LIBOR rates reflects a "market-specific blockage", according to economists at Barclays Capital, "the market is an important one and the longer it continues the more likely it is that higher funding costs will be passed on to firms and households."
Though it's hard to measure, that rise in borrowing costs should slow broader economic activity. Many on the BOE's Monetary Policy Committee won't mind that. Official figures Friday showed the U.K. economy grew at an annual rate of 3.0% in the second quarter, above its trend rate of 2.75%, and the MPC believes that growth is probably even stronger.
Until the recent market turbulence, the hawks on the MPC - including BOE Governor Mervyn King - had been expected to push for a further rate rise this autumn to cool demand and the consequent pressures on consumer-price inflation, until July above the 2.0% target rate for fifteen consecutive months.
But the rise in LIBOR rates could well have done the MPC's cooling work for it.
"Amid action from the Fed and the ECB to inject liquidity in their interbank markets, the Bank of England has conspicuously not taken any special action," said Diana Choyleva, U.K. economist at Lombard Street Research. "Conspiracy theorists may take pleasure in noting that by inaction the Governor gets his hike without the blame or having to convince the rowdy members of the MPC."
To be sure, the BOE is treading a fine line: it won't want troubles in the financial sector to slam the brakes on economic activity too hard. But it may not mind if the credit crunch leads to less of the risky borrowing that has fueled asset prices in recent years.
Peter Matza, policy and technical officer at the Association of Corporate Treasurers, says evidence from its members suggests that's exactly what's happening. He cites mining giant Rio Tinto's ability to raise $40 billion in debt this week as evidence that investment grade borrowers with good growth prospects won't have their sources of funding cut.
"For sub-investment grade companies and those further down the scale, the issue is much cloudier," he says. "A material deterioration will not benefit the economy, but if it can take the froth out of certain markets, that will be welcome."
Certainly the BOE has been consistent in its comments about market conditions, warning in its April Financial Stability Report that market participants should test their positions to assess how well they would perform during a sharp drop in market liquidity.
Now that has come to pass, there's little sympathy in Threadneedle Street for anyone finding conditions not to their liking.
"The MPC will welcome the re-pricing of risk that is currently underway and the tightening of credit conditions this implies," says Ross Walker, U.K. economist at Royal Bank of Scotland in London. "It would be different if the Bank perceived there to be a threat to the financial system as a whole but, absent this, the Bank is likely to remain on the sidelines, relying on markets
to sort things out for themselves."
And while market sources say this has led interbank borrowing and lending to "grind to a halt" in recent days, the BOE's inaction shows it doesn't yet see any threat to the stability of the financial system.
Moreover, analysts say, the rise in money market interest rates could help the BOE to achieve its main objective of taming U.K. economic growth and inflation, while aiding the re-pricing of risk and asset prices it's long warned is needed.
The interest rates banks charge each other to borrow sterling have risen sharply since credit fears began to permeate the market Aug. 9. But in contrast to the U.S. Federal Reserve, the European Central Bank and the Bank of Japan, the BOE has chosen not to lend freely to banks in an attempt to bring those rates down.
The London interbank offered rate has risen particularly quickly for lending of one month or more. The 1-month LIBOR rate had risen to 6.51% by Thursday this week from 5.94% two weeks ago, while the 3-month rate had risen to 6.62% from 6.1% over the same period. Both rates are considerably above the BOE's current target interest rate of 5.75%.
Even the rates quoted are to some extent guesswork, says one market participant who wished to remain anonymous.
"The sterling money markets have apparently ground to a halt in a way that the euro and dollar markets have not - banks are simply not lending any significant amounts of money, even to other banks, let alone non-financial corporations," he said. "In other words, de facto, there is no sterling LIBOR market - LIBOR rates quoted on screens are really 'plucked out of the air'."
Several market sources confirm that BOE officials, up to and including Executive Director for Markets Paul Tucker, have been in regular contact with trading floor heads, and have been made aware how gummed up the market has become.
"They've sounded out a whole range of market sources, but they're not prepared to act," says a source at one of the U.K.'s leading clearing banks who also wished to remain anonymous.
That suggests that the BOE's fundamental belief is that despite market participants' concerns, it's not yet necessary for them to do more than reassure financial institutions about the availability of its standing lending facility - a system by which banks needing funds can tap the Bank, albeit at a penalty rate of interest.
"The bottom line is that there hasn't been a major failure in U.K. money markets: if there were to be one, the BOE would of course step in," said Julian Jessop, chief international economist at Capital Economics in London.
The Bank of England declined to comment on claims that the money markets had ground to a halt, and suggestions that its officials have had extensive contacts with market participants.
The rise in the cost of interbank borrowing could also have some happy side effects for the BOE in terms of its broader policy objectives.
While the rise in LIBOR rates reflects a "market-specific blockage", according to economists at Barclays Capital, "the market is an important one and the longer it continues the more likely it is that higher funding costs will be passed on to firms and households."
Though it's hard to measure, that rise in borrowing costs should slow broader economic activity. Many on the BOE's Monetary Policy Committee won't mind that. Official figures Friday showed the U.K. economy grew at an annual rate of 3.0% in the second quarter, above its trend rate of 2.75%, and the MPC believes that growth is probably even stronger.
Until the recent market turbulence, the hawks on the MPC - including BOE Governor Mervyn King - had been expected to push for a further rate rise this autumn to cool demand and the consequent pressures on consumer-price inflation, until July above the 2.0% target rate for fifteen consecutive months.
But the rise in LIBOR rates could well have done the MPC's cooling work for it.
"Amid action from the Fed and the ECB to inject liquidity in their interbank markets, the Bank of England has conspicuously not taken any special action," said Diana Choyleva, U.K. economist at Lombard Street Research. "Conspiracy theorists may take pleasure in noting that by inaction the Governor gets his hike without the blame or having to convince the rowdy members of the MPC."
To be sure, the BOE is treading a fine line: it won't want troubles in the financial sector to slam the brakes on economic activity too hard. But it may not mind if the credit crunch leads to less of the risky borrowing that has fueled asset prices in recent years.
Peter Matza, policy and technical officer at the Association of Corporate Treasurers, says evidence from its members suggests that's exactly what's happening. He cites mining giant Rio Tinto's ability to raise $40 billion in debt this week as evidence that investment grade borrowers with good growth prospects won't have their sources of funding cut.
"For sub-investment grade companies and those further down the scale, the issue is much cloudier," he says. "A material deterioration will not benefit the economy, but if it can take the froth out of certain markets, that will be welcome."
Certainly the BOE has been consistent in its comments about market conditions, warning in its April Financial Stability Report that market participants should test their positions to assess how well they would perform during a sharp drop in market liquidity.
Now that has come to pass, there's little sympathy in Threadneedle Street for anyone finding conditions not to their liking.
"The MPC will welcome the re-pricing of risk that is currently underway and the tightening of credit conditions this implies," says Ross Walker, U.K. economist at Royal Bank of Scotland in London. "It would be different if the Bank perceived there to be a threat to the financial system as a whole but, absent this, the Bank is likely to remain on the sidelines, relying on markets
to sort things out for themselves."
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