Key interest rate starts to tumble

The London interbank offered rate for three-month US dollar loans is dropping at the fastest pace since January as bankers gain confidence that the worst of the financial crisis is over.

Debt strategists at Credit Suisse Group, Societe Generale and Royal Bank of Canada, three of the 16 banks that provide the data that sets Libor each day, say the declines will continue.

Momentum may be building as signs of economic stability emerge, according to Federal Reserve Chairman Ben Bernanke.

"Not so long ago the main worry was whether the bank you're dealing with was going to be around in three months time," said Ira Jersey, head of US interest-rate strategy at RBC Capital Markets in New York. "Now that concern is on the backburner. We're going to see Libor coming down steadily."

Libor, the British Bankers' Association interest rate that determines borrowing costs on about US$360 trillion ($610 trillion) of financial agreements ranging from home mortgages to corporate bonds, fell to 1.13 per cent last week from 1.33 per cent a month earlier.

The fastest drop since the start of the year, when the rate tumbled to 1.08 per cent on January 14 from 1.42 per cent nine days earlier, coincides with President Barack Obama's efforts to restore the economy and the banking system to health.

The combination of plans to help banks get rid of devalued assets such as mortgage and leverage loans, the first back-to- back monthly increases in consumer spending since the first half of 2008 and an unexpected rise in home sales for February stoked optimism that the worst of the recession is over.

Bernanke told CBS' 60 Minutes on March 15 he saw "green shoots" in some financial markets. Fed programmes to relieve disruptions in credit markets and restore the flow of credit "are having the intended effect", Bernanke said during a speech in Charlotte, North Carolina.

Libor will decline to 1.04 per cent by June, according to the average forecast of 12 banks on the BBA's Libor panel surveyed by Bloomberg News from April 6 to April 9, compared with 1.21 per cent in a survey last month.

Societe Generale, which bet on Libor rising as recently as February, says the rate will fall to 0.98 per cent by the end of the quarter.

"There is a cautious optimism evolving that things are beginning to get better," said Dominic Konstam, head of interest-rate strategy at Credit Suisse in New York. He predicts Libor may drop to about 0.75 per cent this year.

Lending between banks started to freeze in August 2007, when losses from subprime mortgages left financial institutions with billions of dollars in securities and financial contracts they couldn't value.

Credit markets contracted more in September 2008, when Lehman Brothers filed for the biggest bankruptcy in history. More than 60 US financial institutions have failed over the past two years. Global losses and writedowns have swelled to US$1.29 trillion, helping to sink the global economy into its first recession since World War II.

As credit evaporated and stock markets tumbled, investors fled to the relative safety of gold and government bonds. In the five months following New York-based Lehman's collapse, the MSCI World Index of stocks tumbled as much as 36 per cent, gold soared 31 per cent to US$1007.70 an ounce and the rate on US Treasury bills fell to less than zero per cent.

Government bonds returned 53 percentage points more than the Standard & Poor's 500 index, according to Merrill Lynch data, the widest margin since the bank started calculating fixed-income returns in 1978.

The gap between the Fed's target rate for overnight loans between banks and Libor widened to 3.32 percentage points on October 10 from 0.82 percentage point just before Lehman failed and an average of 0.22 percentage point in the five years before credit markets froze. The cost banks said they would pay to borrow from each other soared even as central banks lowered benchmark interest rates and provided unlimited dollar funding.

Every morning, the London-based BBA surveys members of the trade group on how much it would cost them to borrow from each other for 15 different periods, from overnight to one year, in currencies including US dollars, euros and yen.

Now, strategists say, credit is starting to move again. The US Government and the Fed spent, lent or committed US$12.8 trillion, the equivalent of 90 per cent of last year's gross domestic product, to stem the longest recession since the 1930s.

Obama met with more than a dozen chief executives from banks including JPMorgan Chase, Morgan Stanley and Goldman Sachs Group on March 27, imploring them to get credit flowing through the markets again.

In the past month, the MSCI World index rose 15 per cent and gold closed at US$895 an ounce, down 13 per cent from its record high.

- BLOOMBERG