What is the LIBOR?
We have all seen the London Interbank Offered Rate (LIBOR) cited in several articles and news items. What is the LIBOR and how does it affect currency markets including the Interbank Forex? Simply put, the LIBOR is a daily reference rate based on the interest rates at which banks are willing to lend unsecured funds to each other in the London money market.
LIBOR Published Daily
The LIBOR is published by the British Bankers Association and is released daily, usually at 11:45 AM (London Time). It is basically an average of interest rates charged by banks for loans ranging from overnight to one year. There are 16 contributing banks and the reported interest is the mean of the eight middle banks. The rates for shorter loans are considered to be reliable and reflect the rates at which banks are willing to lend to each other. The actual rate can vary several times a day affecting Interbank Forex markets.
LIBOR Used as Currency Reference
The LIBOR is used as a reference for the British Pound and other currencies including the US dollar, Euro, Japanese Yen, Swiss Franc, Canadian dollar, Australian Dollar, Danish Krone and New Zealand dollar. The LIBOR is closely watched by Forex traders and investors and has a profound effect on the Interbank Forex market.
When the LIBOR rises it indicates two things, 1. That interest rates in general are rising and thus LIBOR is also rising, and 2. Lending banks believe the banks they are lending to have a higher risk of defaulting on the loan so the lending bank has to charge a higher interest rate to offset this risk.
When the LIBOR is falling it indicates that 1. Interest rates are falling and thus LIBOR is falling, and 2. Lending banks believe the banks they are lending to have a lower risk of defaulting so the bank does not have to charge higher interest rates to mitigate the risk.
LIBOR and Interbank Forex
The interbank Forex market is strongly affected by the LIBOR reports. The LIBOR signifies several rates that are calculated in 10 different currencies and is set every business day. The LIBOR rate is calculated daily for these currencies,
- Pound Sterling (GBP)
- United States Dollar (USD)
- Japanese Yen (JPY)
- Swiss Franc (CHF)
- Canadian Dollar (CAD)
- Australian Dollar (AUD)
- Euro (EUR)
- Danish Kroner (DKK)
- Swedish Krona (SEK)
- New Zealand Dollar (NZD)
The LIBOR for a specific currency depends on the local interest rate for the currency, such as the Fed rate for the UDS, and banks’ expectation of future rates. The LIBOR is important to markets including the Interbank Forex for a variety of reasons; it is long established, it is a truly international reference rate, it has a wide commercial use, it offers the largest range of international rates, and its mechanism is transparent. The banks providing the data for the LIBOR are the most active in cash markets and have the highest standards and credit ratings.
LIBOR Has Major Influence on Forex Markets
Unfortunately individual investors do not have access to LIBOR data and to receive LIBOR reports must be licensed by the British Bankers Association. The LIBOR is easily one of the most important reports watched by Forex traders and has a major influence in Interbank Forex markets globally.
