Liquidity crisis grows as Libor rates gap hits 20-year high


By Philip Aldrick
The Telegraph, London
Wednesday, September 5, 2007

Pressure is mounting on the Bank of England to intervene in the credit crisis after money-market lending rates jumped to a 20-year record and economists warned that central banks have "not properly recognised the dangers" ahead.

Hedge fund Synapse Investment Management became the latest market casualty, shutting a E200 million (£135 million) fixed-income fund due to "severe illiquidity," as the gap between the Bank of England's base rate, 5.75 percent, and the three-month inter-bank lending rate (Libor) reached 1.05 percentage points -- its widest since the mid-1980s and a clear sign of the ongoing credit crunch. Libor is now 6.8 percent, the highest it has been since 1998.

Patrick Perrett-Green, director of European derivatives and bond trading at Citi, said: "The reality is that central banks don't know how to deal with the current situation within the confines of their existing rulebooks. ... In short, things are a mess and unless central banks start to properly recognise the dangers, the situation could reach critical."

He called for an urgent cut to interest rates.

Economists at Capital Economics warned that liquidity problems are more extreme in the UK because the Bank of England "has been less generous in its provision of emergency funding" than the US Federal Reserve and the European Central Bank, which have lowered borrowing rates and injected short-term liquidity into their markets. The gap between the inter-bank lending rate and the base rate in the US is just 0.4 percentage points and 0.8 percentage points in Europe.

The ECB's intervention appears to have revived Europe's credit markets. HBOS, which owns the Halifax, completed a E2 billion fundraising yesterday but was forced to look to Europe because of the seizure in its home market. It had originally hoped to raise E1 billion through the low-risk covered bond, but investor demand doubled the issue. It was priced at roughly the same rate as a covered bond the bank issued in June, before the credit crisis. Nationwide now intends to follow suit.

Evidence has also begun to emerge that the liquidity crunch is spilling into the wider economy, increasing the pressure on the Bank of England to act. Nationwide's consumer confidence index showed that "the number of people who think that now is a good time to make a major purchase such as a house or a car has fallen to a new low of 15 percent."

Nationwide's chief economist, Fionnuala Earley, said: "Recent events such as the turmoil in the financial markets may be having something of an impact on sentiment." She added that "one bit of good news for consumers is that the unexpectedly large fall in inflation, along with financial market unrest, means it is now less likely the Bank of England will feel that a further hike in interest rates is necessary."

The bank makes its monthly decision tomorrow and is widely expected to leave rates on hold.

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