The key three-month Libor rate, influential in pricing bank lending rates, has plunged more than 1%. Sterling three-month Libor drops from 5.56% to 4.49%, it was announced this morning. Libor is the rate at which banks lend to each other and so therefore influences mortgage rates, especially the price of new tracker deals.
The fall has come far quicker than expected. It took nearly a full month for October’s 0.5% reduction to be reflected in the three-month Libor rate.
Banks’ lending rates are influenced by three primary factors:
- The rate at which they can borrow from other banks and financial institutions, which is dependent on Libor rates and money market swap rates.
- The rate at which they borrow from the Bank of England – the so-called base rate.
- The rate at which they can borrow from customers in the form of savings accounts.
Libor, created in the mid-1980s, had traditionally tracked 15 or 20 basis points above the bank rate. But toxic debt from the subprime crisis caused distrust between banks, which were reluctant to lend to one another. So Libor spiked in August 2007, detatching from its usual bank rate relationship.
It had started to fall as some confidence returned in the summer months. This soon fell away with the collapse of Lehman Brothers in September. It peaked at 6.3% on 30 September and then steadily fell to yesterday’s rate of 5.56%.
That leaves the gap between bank rate and Libor at nearly 1.5%. Before the cut yesterday, the difference was 1.06%. Libor should continue to fall in the next few days if there are no further financial shocks.