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Thu 25 September 2008, BBC News

Bank of England unmanned

By Robert Peston
Conditions in money markets have worsened again overnight and this morning. Rates for lending between banks for longer than just a day or so have risen again. Hoarding by bankers is on the rise. Given the choice between making a bit of extra profit by lending cash and simply keeping the cash at hand to meet any possible emergency, well bank treasurers - under pressure from their chief executives - are opting for extreme caution. This is very bad news for the Bank of England . It means that - again - there has been a partial breakdown in its ability to control demand in the economy, and hence inflation and growth, via changes in its policy rate. The Bank does not explicitly target three-month sterling Libor, the three-month rate for lending between banks. But when it moves its policy rate, the Bank of England expects that to have an influence on the rates that households are charged for mortgages and personal loans and that companies are charged for their debt. The Bank of England hopes to transmit its changes in interest rates to the rates we pay via interbank rates - of which probably the most important is three-month Libor. So it must be worrying for the Bank of England's Monetary Policy Committee that it has maintained its policy rate at 5% but three-month Libor is well over 6% - and still rising. What's more, this rise in thee-month sterling Libor has come at a time when the market actually expects cuts in the policy rate (as shown by the three-month OIS rate I mentioned yesterday in my note on " interbank hysteria "). There are already signs of banks and building societies pushing up mortgage rates again. And I've been contacted by businesses who say they can't obtain new loans at any price. The most basic function of the banking system, to channel funds at the right price to those who can best use it, has broken down. Which, to reiterate what I said last night, is why it is almost inconceivable that the Bank of England won't take corrective action by lending tens of billions to banks at maturities significantly longer than overnight (as I said yesterday, paradoxically there's far too much overnight money sloshing around). The Bank of England's existing emergency scheme, which allows banks to swap mortgages created before the end of last year for liquid Treasury bills, the equivalent of cash, was helpful. And banks should count their blessings that the closing date for this scheme has been extended to January. And I can see why the Bank of England may want to wait a bit before doing more - to obtain a firmer grasp of just what kind of bank bail-out scheme may eventually be approved by Congress. But it may be a long and nerve-wracking wait before a sensible assessment can be made of whether the US Treasury has done enough to restore some kind of stability to the global banking system. And it may be dangerous to rely too much on the US to solve our domestic banking difficulties. If we want our banks to do their job properly - if we want the basic infrastructure of the economy to function as it should - the Bank of England will surely have to prime the pump again.
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