Bank of England Drains Overnight Pounds as Long-Term Rates Rise

By Brian Swint

Sept. 23 (Bloomberg) -- The Bank of England drained funds from overnight sterling lending markets as financial institutions hoarded money and pushed the cost of borrowing for longer periods to the highest level this year.

The U.K. central bank held a fine-tuning auction to remove 10 billion pounds ($19 billion) from money markets. The overnight lending rate for pounds fell to 4.5 percent today, lower than the 5 percent benchmark rate. At the same time, one-month, two-month and three-month lending rates rose.

``Overnight rates have gone down an awful lot,'' said Jason Simpson, an analyst at Royal Bank of Scotland Group Plc in London. ``Going further out, it's clear that banks are still quite reluctant to lend. The central bank has tried to get those money rates down, but there are powers beyond their control.''

The Bank of England's action underscores the challenge faced by central banks worldwide to restore confidence to money markets after the bankruptcy of U.S. investment bank Lehman Brothers Holdings Inc. last week. The tension threatens to further undercut U.K. mortgage lending after loan approvals fell to a record low last month, data released today show.

The Federal Reserve opened up swap lines with the Bank of England, the European Central Bank and the Swiss National Bank last week and will start another one with the Bank of Japan tomorrow. The auctions put an additional $80.1 billion into overnight dollar money markets today. The London interbank offered rate, or Libor, was still 2.95 percent for dollars today, almost a point higher than the Fed's benchmark rate at 2 percent.

BOE Auction

The Bank of England, which offered $40 billion in its overnight dollar auction, allocated $30.1 billion, the most since the emergency sales began last week.

At the same time, financial institutions deposited 9.5 billion pounds at the bank yesterday, the most since it started the current standing deposit facility in May 2006. The move is a sign they couldn't lend pounds in the overnight market at a better rate than the 4 percent penalty rate offered by the central bank.

While the Bank of England has succeeded in bringing down the overnight rate for pounds, the three-month lending rate was 6.07 percent today, the highest since Dec. 21.

The government nationalized mortgage lender Northern Rock Plc earlier this year after the surge in three-month interest rates dried up its funding. HBOS Plc, the country's biggest home-loan provider, agreed to a rescue takeover by Lloyds TSB Group Plc last week after Prime Minister Gordon Brown pledged to waive merger scrutiny on the deal.

Government Action

With house prices falling at the fastest pace in a quarter century, according to HBOS, the government should weigh whether to do more to shore up the mortgage market, Goldman Sachs Group Inc. Chief Economist Jim O'Neill told Bloomberg Television today.

Brown should consider ``doing something to take over the activities of all those institutions that are just not in a position to lend here any more, because it's going to end up causing significant economic weakness in the U.K.,'' O'Neill said.

The U.K. central bank last week extended its Special Liquidity Scheme that allows bank to swap mortgage-backed debt created up to last year for government securities.

``I don't know what else they can do,'' RBS's Simpson said. ``There's still funding for banks using mortgages as collateral, but even that hasn't quelled the uncertainty. Things could remain like this for quite some time.''

To contact the reporter on this story: Brian Swint in London at bswint@bloomberg.net.