LIBOR rates well above BoE base rates… (What that means, and why it’s not good news.)

Bob Preston, in most recent his comments about the Northern Rock crisis, has noted that:

“Well three-month sterling Libor has been climbing for the past fortnight and is back at almost 6.6 per cent – well above the Bank of England’s policy rate of 5.75 per cent. It means that funds for banks are both expensive and are still relatively difficult to obtain.”

Libor (the London Inter-Bank Ordinary Rate), is the rate at which “mainstream banks” can borrow from each other. As I said in my article about securitisation:

“lenders tried to get customers to accept mortgages tied to LIBOR, so if the rate THEY had to pay went up, customers would pay them more.”

That’s to say, the bank would loan me money at “LIBOR plus 1%”, and borrow money at “LIBOR” – so make 1% profit each year (which, on a B2L mortgage, is easily enough to cover the admin costs and make a nice earner for them, particularly given they’re not tying up their own cash to do so.)

The problem, though, is that LIBOR is a “market rate” – that’s to say, a rate set by the place where “how low a rate banks with money are prepared to lend it for” and “how high a rate banks who need money are prepared to pay.” As with any market rate, it goes up and down.

The Bank of England Base Rate, on the other hand, is a rate set by public servants, specifically the Monetary Policy Committee of the BoE. It changes, at most, once a month.

When LIBOR moves much above the base rate, it doesn’t just affect mortgages tied to LIBOR – it suggests that the banks’ analysts believe that the BoE base rate is too low.

If the MPC agree with those analysts, then expect more rises.

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Possibly related posts: (automatically generated)

• What is Mortgage Securitisation anyway, and does it matter? It did to North…
• Central Banks and strange games
• Bank Rates Cut, but don’t expect the savings to be passed on