The UK funding gap

The focus now is naturally on whether the Bank of England will sanction more QE at this week’s MPC meeting, but there are other issues that the Bank should be thinking about at this point in time. What has been notable in the money markets is the contrast between developments in sterling markets compared to the dollar and the euro’s. More specifically, whilst Libor-OIS spreads have been steady to slightly wider for sterling (essentially measuring the premium attached to unsecured interbank lending), they have been falling for both dollars and euros.

As the chart shows, the spread for euros moved above that for sterling in the middle of last year, as the eurozone sovereign crisis really began to bite. Indeed, the gap between the two was as wide as 40bp towards the end of last year. Now it’s just over 10bp. Of course, the injection of 3Y cash from the ECB in December played a key part in the fall of the Libor-OIS spread for euros, but more to the point is the fact that the sterling equivalent has not fallen at all over this period.

At the same time, UK banks have around GBP 140bln of term funding due to mature this year, with the majority of this occurring in the first half of the year. There has also been evidence (as mentioned in the BoE’s latest Financial Stability Report) of the duration of short-term funding falling most significantly for UK banks, which increases the roll-over risk.

The Bank’s special liquidity facility, which officially ended at the end of last month, was introduced back in 2008 as a way for banks to swap high quality assets for UK Treasury bills. Furthermore, the BoE appears keen for UK banks to sort their own balance sheets out, as was detailed in December’s Financial Stability Report. Quantitative easing can only go a small way towards improving the short-term funding strains, for instance by increasing asset values. We doubt that the Bank will introduce a new scheme, or alter existing facilities, to improve the liquidity position of UK banks, but the issue should be on their radar for this week, especially given the contrast with the eurozone market.