Tough Interest rate questions

[bullboy8]

1. Can someone explain what precisely is the Bank of England base rate. Is it the rate at which the BOE lends money overnight to banks? In which case, why would a commercial bank ever borrow from another bank (at a higher rate at the LIBOR?) or is it the interest that the BOE pays on overnight deposits by the Banks? If the latter, then it is difficult to see why the base rate would ever have much of a correlation to LIBOR.

2. If the base rate is the rate BoE lend to commercial banks that fail to keep a postive balance in the BoE ac, then why would commercial banks not borrow loads of money from BoE and lend it out in the MOney market?

3. I know that commercial banks need to keep an average reserve each month and is the average is lower or higher it needs to pay interest at base rate to BoE but if remains an average same, then the BoE pays commercial bank. So, my question is, if commercial banks can borrow money from BoE at base rate then they will never go higher or lower than the monthly average.

Thanks

 

[A Dashing Blade]

1. Can someone explain what precisely is the Bank of England base rate. Is it the rate at which the BOE lends money overnight to banks?

Yup, but there's no assumption about the amount that the BoE will lend hence the need for banks to use the Libor rate (ie borrow/lend between themselves).

2. If the base rate is the rate BoE lend to commercial banks that fail to keep a postive balance in the BoE ac, then why would commercial banks not borrow loads of money from BoE and lend it out in the MOney market?

See above ie the BoE does not lend out infinite amounts of money

3. I know that commercial banks need to keep an average reserve each month and is the average is lower or higher it needs to pay interest at base rate to BoE but if remains an average same, then the BoE pays commercial bank. So, my question is, if commercial banks can borrow money from BoE at base rate then they will never go higher or lower than the monthly average.

This question is a little unclear but I think I've answered it ie the BoE does not lend out infinite amounts of money

Thanks

My pleasure

 

[bullboy8]

thanks..i guess your one answer answers all my questions.

The last question (I quote directly"

"As the commercial banks make payments to, and take payments from, other banks, their reserves go up and down. However, they must maintain a steady amount over the month when taken as an average. For example, if the hypothetical "Hamster Bank" decides to put £2bn of reserves into the BoE, the average for the month once calculated at the end of the month must be £2bn or it will have to pay interest to the BoE. That is the case if the average is lower OR higher than £2bn. If it maintains £2bn the BoE pays interest to "Hamster Bank"."

Source: How the bank makes money markets work | Business | guardian.co.uk

Also, i remember reading from somewhere, the BoE only lends on Thurday via the "open market operations", is this correct.

 

[A Dashing Blade]

Ahh, the Grauniad's talking about the "Reserve-Averaging Scheme"

Summery here . .

Bank of England|Markets|Sterling Money Market Operations

Details here . . .

http://www.bankofengland.co.uk/markets/money/publications/redbookfeb07.pdf