reporadar™

3-month Sterling LIBOR was today set at 4.49625pc, a massive 106.5 basis points lower than yesterday’s pre-cut print of 5.56125pc for the popular interbank lending rate.

The key interbank rate had been drifting lower since it peaked a month ago at 6.30pc, prior to the joint Central Bank rate cutting on October 8th. Fuelled by expectations of a 50 basis point cut yesterday, it had continued its downward trend having already started to baking in the expected Base Rate cut.

For existing borrowers, the impact of the lower LIBOR rate may still be limited. Whilst those with Base Rate or LIBOR tracker rate mortgages should see the benefit eventually, subject to the collar rules of their mortgages, the reductions in both the interbank rate and the Base Rate will mean nothing to those with fixed rates.

Those with Standard Variable Rate mortgages, estimated by the Council of Mortgage Lenders to be less than 10pc of mortgagors, will be at the mercy of their lender. Yesterday Abbey and Lloyds TSB said that they would pass on the full 1.5pc Base Rate cut to their Standard Variable Rate mortgagors.

It is for new lending where lower interbank rates are going to prove most important since it is the rate banks charge each other and, ultimately, charge consumers on their new loans and new mortgages which will influence, amongst other things, the strength of retail sales and the housing market.

However, despite the reductions in interbank rates, liquidity is unlikely to ease in the short term. In an environment of continued deleveraging, end-of-year balance sheet straightening and with a deepening recession in the UK and beyond, banks will not be falling over themselves to lend for some months yet. Even when they do, criteria will still be considerably tighter than pre-Crunch, limiting any potential upside in house prices for quite some time.

For now, mortgages are expected to remain tight. The secular bear in home ownership is expected to continue as the total number of mortgagors continues to contract. Even if Q2 2009 does see a nadir in nominal prices, and that is a big and unlikely if, growth in repossessions will continue for sometime after that. Bull trends in repossessions start before house prices peak and end several quarters after nominal prices bottom.

At midday the markets were caught off-guard as the two-day meeting of the Bank of England’s Monetary Policy Committee concluded by surprising everyone with a massive 1.5 percentage point cut in the Base Rate, slashing it to just 3.0pc, the lowest level since 1955.

With recession deepening and house prices still in free fall, they are now down nearly 20% in RPI-adjusted terms since their peak last year, there will be a hope that such a spectacular cut can put a floor under the economy, although nothing can be done about the damage already inflicted by not acting sooner.

However, the key to any cut will be how fast it is passed on to the consumer. It is the cost which banks charge each other which is paramount here and that is the LIBOR rate. Having been as low as just 16bp before the Credit Crunch, recently the difference between the Base Rate and the 3-month LIBOR rate was up around 180bp. In the last couple of weeks 3-month LIBOR had fallen back to under the 120bp mark and it will be hoped that today’s decimation of the Base Rate will result in both the nominal and relative interbank rates coming down.

To put any floor under house prices, falling rates will also need to be matched by increased Loan-to-Value ratios for borrowers. Higher LTV ratios will be especially important given the needs of first-time-buyers and movers with negative equity.

It is highly unlikely that today’s shock-and-awe rate cut will lead to an immediate V-shaped bounce in house prices, but it could begin to provide a base on which prices could stabilise.

Realistically, prices need to fall another 10%-15% to encourage more buyers from the sidelines. It is important though that any continued declines in house prices are at a slowing rate. When prospective buyers notice that they will then begin to feel that a bottom is near. And that, combined with low interest rates and higher LTVs, will be what begins to get the housing market moving again.

Today’s decisive action by the MPC is hopefully the first step along that path.