Libor Starts To Move Lower. The freeze thaws.
Written by A Forex View From Afar on Friday, October 31, 2008Following the global rate cuts and the impressive measures taken to ensure liquidity in the financial markets, the Libor rates are starting to show signs of relief.
The 3-month dollar Libor, or the rate at which banks borrow money from other banks with a maturity of three months, declined for a full 14 days, to 3.19%. The overnight dollar Libor rate, used to fund overnight activity, dropped to 0.79% a record low as the market expects more rate cuts to follow shortly.
Action taken by the ECB, looking for a similar outcome, driving the inter-banking rates lower, the central bank has pumped over a $1 trillion into open market operations. The euro 3-month Libor rate also declined yesterday for the 14th consecutive day, down to 4.83%.
However, even though short-term rates are at very low levels due to the huge liquidity central banks provide, banks still do not lend on longer maturities. The spread between the shorter-term and the longer-term loans is still very large, despite recent declines. The 3-month dollar Libor is 220 points above the Fed’s rate, compared with just a few dozen points in normal market conditions.
The question now is how low and how quickly will the rates fall. Central banks are now walking at the “extreme end” of monetary policy. Central banks operate by influencing short-term rates, and hoping (it is really hoping) to move the longer maturity rates; very similar to a whip. However, as banks are reluctant to loan to each other, a central bank has practically no control over the “end” of the whip, thus, the high spread between the shorter-term (which are at record lows) and the longer interest rates.
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