Libor

It is one thing to set an interest rate; it is quite another to make it stick. The back-slapping among the world's central bankers – many of whom staged a historic joint rate cut on Wednesday – lasted almost exactly 24 hours.

Just before noon the next day, with the publication of the latest Libor poll, the banks themselves merely shrugged. Overnight rates eased a little but almost everything of a longer maturity in any currency continued to climb. The message was clear: you can drop the price of money all you want but you won't get us back in the market.

The reasons for banks' reluctance to lend to each other are by now well understood: chiefly, the fear that they will never see the money again.

But, as banks move deeper into the fourth quarter, the pressure to shore up their books for year-end creates another compulsion to hoard cash. The funds that banks are drawing from central banks are mostly being used to mend their own balance sheets, rather than recirculated. Last year saw a squeeze on interbank lending in the same period, when the crisis was nothing like as severe.

Prices on the deals that are actually getting done, as seen in the Fed funds effective rate, support the idea that interbank lending is a barely functioning market. The standard deviation of the reported overnight trades facilitated by the Federal Reserve on Wednesday was 160 basis points – wider than the Fed's nominal rate of 1.5 per cent.

Interbank rates telegraphed the severity of the crisis last August, when Libor first diverged from central bank rates. Now, the difference between three-month Libor and the rate the US Treasury pays for equivalent money is 10 times wider than the average gap since 1990, and keeps widening. Less gloomy equity markets may suggest that the worst is over. The banks beg to differ.

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