Bank primes money pump
The Bank of England’s stiff upper lip has relaxed just a fraction. For the first time since the global financial system seized up more than a month ago, it has taken what looks awfully like evasive action.
It is endeavouring to relieve the upward pressure on short-term interest rates that has been caused by the global squeeze on credit by doing two related things – whose combined effect represents a commitment to pump up to £5.4bn of short term loans into the banking system.
That said, the Bank is insistent that it is acting within published guidelines: it has not rewritten its own rules about its role in the money markets.
Or to put it another way, it is still drawing a distinction between its own behaviour and that of the US and Eurozone central banks – both of which have behaved in a more exceptional way.
For me, however, that is a nice distinction. What it has announced today is hardly trivial. It is probably more significant than tomorrow’s monthly statement by the Bank’s Monetary Policy Committee on the base lending rate.
Having injected liquidity into the system today, I would be staggered if the MPC did anything but keep the base rate on hold.
What exactly has the Bank done?
First, it has agreed that banks can deposit £17.6bn in the coming month at the Bank of England – a rise of 6 per cent or just under £1bn from the reserve target of the past month.
Banks can draw on these facilities as and when they need cash in the coming days.
That may not sound terribly significant, unless you are versed in the arcana of central banking. But the point is that the Bank of England actually provides these reserves to the banks via loans to them backed by gilts and other collateral.
An increase in the reserve requirement is in effect an increase in lending to banks at the base lending rate of 5.75 per cent.
It represents a significant increase in the liquidity of the banking system – and relieves pressure on the banks to borrow at the higher penalty rate of 6.75 per cent.
Second, if that isn’t enough to bring down overnight borrowing rates, the Bank will supply up to a further 25 per cent of the aggregate reserves target in its so-called open market operation next Thursday.
Or to put it another way, it is prepared to lend banks a further £4.4bn at the base lending rate.
In crude terms, the Bank is basically providing additional cheap finance to the banks to meet any short term requirements they might face.
The Bank’s explicit aim is to bring down the rates which banks charge each other for overnight borrowing to something closer to the bank base rate.
It insists its actions are not specifically aimed at bringing down the three-month Libor rate for loans between banks, which has been at more than one percentage point above the base rate – much more than usual.
That said, any increase in liquidity in the banking system should – in theory – have some effect on longer term rates such as three-month Libor.
The market for three-month money is not totally discrete from the market for overnight money. So what the Bank has done may ameliorate the horrible conditions in money markets.
But it won’t bring the crisis to an end. On its own, these measures won’t suddenly persuade banks to start lending to each other and other financial institutions with the alacrity of yore.