Good morning and welcome to today’s foreign exchange market commentary on Friday, the 11th of August.
Making the Libor transparent
Following the sensational revelation of regular manipulation of the London Interbank Offer Rate by participating banks that have already claimed three scalps from Barclays, Libor has become a dirt word and regulators need to move fast. Unfortunately, trashing the benchmark is not an option since the rate acts as a pivot for derivatives contracts and loans exceeding $350 trillion.
Everyday a group of banks publish rates at which they can borrow from peers under the supervision of the British Bankers Association, submitting 150 rates in 10 currencies with maturities ranging between overnight to one year. After chopping off the top and bottom quartiles, Thompson Reuters averages the remaining rates to produce the official rate.
The problem with the current set up is that the submitted rates are best guesses, and hence open to manipulation, as demonstrated by Barclays. Secondly, in times of difficulty, banks have an incentive to submit artificially low rates lest markets can make out they are stressed.
Reforms proposal have suggested best guesses should be replaced by actual transactions. But the pertinent question to ask is what happens when markets panic. If banks stop lending each other, as happened during 2008 and is happening currently in parts of Europe, very few rates will be available. Also problems may arise due to insufficient volume of say, rates quoted in Swiss Francs for longer maturities for rates to be truly representative.
However, the problems are not insurmountable. The number of Libors can be restricted to most liquid maturities, as suggested by the New York Fed in 2008. Most derivatives are priced off three month Libors anyway.
Oversight also remains an important issue as the BBA’s self-regulation has been a non-starter. A more realistic solution would be to involve the new Financial Conduct Authority to check abuse. Banks should be directly held responsible for the submissions they make.
CURRENCY RATES OVERVIEW
GBP/EURO – 1.2701
GBP/US$ – 1.561
GBP/CHF – 1.5255
GBP/CAN$ – 1.5514
GBP/AUS$ – 1.4835
GBP/ZAR – 12.6744
GBP/JPY – 122.50
GBP/HKD – 12.1127
GBP/NZD – 1.9281
GBP/SEK – 10.4690
EUR: The single currency weakened further against the greenback yesterday despite Bank of France governor and ECB Governing Council member Christian Noyer saying the council approves market intervention by the central bank. The GBP/USD pair slipped further to 1.2270 from 1.2360 on the back of lackluster Chinese economic data. French Industrial production data also disappointed, coming in flat against an expected 0.4 percent rise. Euro has lost ground against the cable over the past 24 hours and the GBP/EUR pair dropped below the 1.2700 handle. The GBP/EUR pair opens at 1.2695 this morning.
USD: Sterling lost ground against the USD yesterday after data released showed UK trade deficit had widened in the second quarter to a record high of £28.3 billion from £25 billion in the previous quarter. Risk sentiments suffered further over weaker than expected Chinese trade figure balances, fuelling a sell out as the market braces for the weekend. There’s little economic data due from the other side of the Atlantic and market reaction to UK PPI data is expected to be muted due to summer holiday trading conditions. The GBP/USD pair opens at 1.5585 this morning.
