Does the amount of business being done at LIBOR (6.17%) related rates manifestly weaken the effect of BoE base rates (5.75%) ? To my simplistic way of thinking, governments are good for billions, but international finance is good for trillions.
Daytona
It's borrowing that's the problem - it's hard to borrow at the BoE base rate, most institutions are forced to borrow at LIBOR plus a spread. If you want to borrow for 3 months you'll have to pay 3 month LIBOR + spread.
That's what I was wondering. So the government/BoE is happily going about their business thinking that they can control the economy using base rates, when, unless the base rate happens to be moving in the same direction, or is similar to LIBOR, they're living in cloud cuckoo land ?
Daytona
I understand how Libor affects borrowing rates, via futures, swaps etc. What I do not understand is how the base rate affects Libor or other borrowing rates.
I did a quick Google and was informed that the base rate was the rate at which the BOE lends to business. What I couldn't find was what form these loans take and what the level of business in these loans was.
It is clear that there is a very close correlation between the overnight Libor rates and the base rate, I just don't understand what causes it.
Interest rates are a product of supply and demand for credit. The Bank of England is capable of supplying or withdrawing credit from the market and the Base Rate indicates the market-clearing price it would prefer. Market participants, knowing this, adapt their behaviour accordingly and, unsurprisingly (as they know that the Bank stands ready to buy or sell to drive the rate up or down), the market-clearing rate (a bit less than LIBOR) does not differ much from the rate at which the Bank could decide to intervene.
How does the BOE supply or withdraw credit. What instruments does it use. How does it calculate the market-clearing price?
If this is the case why did this mechanism stop working. Why did we see LIBOR move away from the base rate.
It buys and sells a variety of instruments, including gilts and the like.
How does it calculate the market-clearing price?
You mean the one it wants ? A committee of experts consider a slew of data and factors and then - allegedly - close their eyes and stick a pin
The Bank is powerful but not omnipotent.
Those are all complicated questions more appropriate for a specialist in the London money markets, which I am not.
I may be completely wrong here, just some observations though.
Gilt yields have not moved away from base rate in the same way that Libor has.
The redemption yield on 3 month Gilts is 5.83% vs 6.24% for 3 month Libor. So you can get 0.41% more for lending to a bank than lending to the government. This must presumably mean that banks are considered that much more risky than governments.
I don't really know anything about gilts. I always think of them being used as relatively long term instruments.
Firstly Gilt maturity is December which is two months. But even so the apparent yield does seem much lower. I find it hard to believe such a spread is due to a credit rating.
That doesn't sound right. It is the overnight LIBOR rate that shows the tightest correlation. Gilts are generally much longer term. I believe the BOE must have a way of affecting the overnight rate.
I do know it does emergency overnight lending at 100 bips above the base rate, but I don't see how this causes such a tight correlation with the base rate itself.
Do you know where I could find this information out?
No I meant the how do they calculate what the market clearing price is, not what they want it to be.
Fair enough the literature about does seem to involve a lot of arm waving when it gets down to specifics.
In message , Nick writes
Gilts are generally issued as long term notes but they get younger every day and eventually every dated gilt will have just three months to run.
What do you mean? Gilts can be set to mature at whatever date is written on them, which isnt necessarily December.
Yes, I agree. Some is due to the risk rating, the rest is due to liquidity and marketability. Usually, the gilt market is always liquid and there are well established market makers in Gilts, thereby reducing the risk even more and also reducing the redemption yield.
LIBOR dosh can, in theory, be traded or 'swapped' but it relies on there being a willing buyer. Short term LIBOR isnt as tradeable as short term Gilts.
The outcome = a higher price.
Sorry I'm very ignorant about gilts I assumed they we issued for standard months, when I looked at the FT they only gave a quote for December and March etc.
I'm not sure about liquidity or volume of gilts vs libor I couldn't find these figures. But I did find comments about Repo trades being preferred for short term lending (overnight to 10 days). So I suppose the BOE could be using this market to affect the short rate.
It would have be nice to find something a bit more explicit.
Thanks for your help.
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