G7 three-month LIBOR – a weighted average of individual currency rates – has fully reversed its September / October spike and is now below levels prevailing before Lehman failed. 10-year interbank rates are also at a new low – see chart.
Less encouragingly, the fall in LIBOR has been entirely due to actual and expected cuts in official rates, reflected in a large decline in overnight indexed swap (OIS) rates. LIBOR / OIS spreads remain significantly higher than in early September.
The lower absolute level of rates will support the economy, partly by boosting the disposable income of borrowers whose loans are tied to LIBOR or policy rates. However, banks’ continuing difficulties in raising wholesale funds, reflected in high LIBOR / OIS spreads, will constrain the supply of new credit.
As argued previously, policy-makers need to shift emphasis from official rate cuts to direct measures to boost money and credit, such as underfunding budget deficits, buying private sector assets and guaranteeing lending to firms and households.
