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New Star warns BoE liquidity scheme may be ineffective

The Bank of England’s special liquidity scheme may prove ineffective because of its unattractive fee structure, according to New Star.

The asset management company is warning that the scheme is similar to the term auctions of three-month funds last autumn, which attracted no bidders because the minimum bid rate was set at a penal level.

Chief economist and strategist Simon Ward says: “The fee payable on a swap of mortgage-backed securities for Treasury bills will be the spread between three-month LIBOR and the three-month gilt repo rate – currently about 100 basis points. A floor has been set at 20 basis points but is irrelevant. Banks will use Treasury bills to obtain funds in the market at the gilt repo rate. Their total cost of funding – including the fee – will therefore equal LIBOR.”

Ward says the scheme will help any institutions currently unable to access interbank funds at LIBOR but seems unlikely to result in a significant reduction in the current wide LIBOR-Bank rate spread.

He says: “There is a danger that use of the scheme will be interpreted as an admission of weakness. The major banks may have agreed to participate in the scheme regardless of their need for funds to mute this signalling effect.

“The relatively restrictive nature of the scheme suggests the LIBOR-Bank rate spread will remain elevated and the onus will be on the Bank’s Monetary Policy Committee to bring market rates down via further cuts in its Bank rate.”

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