Libor anticipated changes lead to sharp rate rises

Libor anticipated changes lead to sharp rate rises





US and European interest rates jumped last week on fears of inflation and concerns that there would be a change in the calculation of London Interbank Offered Rates (Libor).


The British Bankers Association (BBA) meets at the end of the month and bankers will discuss an advisory report which will discuss changes to Libor, the interbank benchmark for US dollar, euro, yen, sterling and other short-term interest rates.


Since the credit crunch began in the middle of last year, Libor has been volatile, with spreads over US Treasury bills and European government and Japanese rates tending to widen. Libor reflects the market for interbank borrowing. Rates are at a premium over government paper because participants are wary about troubled banks and the possibility of failures.


US three-month Treasury bills are currently on yields of 1.82 per cent, but three-month dollar Libor rates are 2.9 per cent. Interest rate experts and economists have raised questions whether those banks were providing accurate quotes. A three-month dollar rate is calculated, for example, even though banks rarely actually borrow or lend to one another at that maturity. Similarly, German three-month interest rates are 3.93 per cent, but the euro libor rate is 4.85 per cent; three-month UK treasury bills are 4.85 per cent, but three-month sterling Libor is 5.77 per cent while yen three-month treasury bills of 0.6 per cent compare with yen three-month Libor of 0.9 per cent.


Following months of turmoil, bankers want to change the Libor formula, which comes from the input of 16 participating banks on the grounds that the benchmark fails to adequately reflect conditions in the money market. The BBA, however, is reluctant to institute radical changes as it fears this could adversely affect nervous investors. Libor is calculated each day by the BBA not on the basis of actual deals but instead as an average of what 16 banks, which include only three US-based institutions, believe to be the cost of short-term finance.


The US Federal Reserve Board and other central banks are concerned that Libor is well above treasury rates and fear that the knock-on interest rate effect will continue to dampen economic growth. Central banks regard Libor as a barometer of the banking system’s health. It is the basis for rates on trillions of dollars of global corporate securities, interest rate contracts and mortgage loans


Source: Business Times

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