The recent injections of liquidity by central banks appear to have played a major role in pushing interbank interest rates back towards more normal levels. Three month LIBOR in the UK is now just 10 basis points above the repo rate. That said, given that the repo rate is expected to be cut in February, three month LIBOR might normally be expected to be lower than the repo rate. As such, money market distortions have not disappeared altogether. What’s more, growing evidence that the damage from the previously high level of LIBOR has already been done supports our view that interest rates will eventually fall all the way to 4%.
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