Official Interest Rate

By: EconomyWatch Content   Date: 4 November 2009

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The official interest rate of the UK is called LIBOR (London Interbank Offered Rate). It is a reference rate based on the rate of interest at which banks borrow funds from other banks in the inter-bank market or the London wholesale money market. This official interest rate is used as a reference rate for financial vehicles including shorter-term interest rate futures contracts, forward rate agreements, interest rate swaps, floating rate notes, inflation swaps, currencies, variable rate mortgages and syndicated loans.

Official Interest Rate – Features of LIBOR

The British Bankers’ Association (BBA) publishes the LIBOR everyday while Thomson Reuter calculates it. This official interest rate is an average of the inter-bank deposit rates of designated contributor banks for maturities that range from overnight to a year. LIBOR rates are benchmark rates rather than tradable rates. The actual rate, however, varies throughout the day.

Official Interest Rate – The Importance of LIBOR

The sterling three-month LIBOR rate affects the rates lenders establish on loans to consumers and businesses. This rate also affects the amount they lend. Since the LIBOR rate is linked to a lender’s costs, mortgage deals are increasingly linked to LIBOR rates rather than bank rates. The countries that rely on LIBOR rates as reference include Canada, the US, Switzerland and the UK. 

Official Interest Rate – Eurodollar Contracts

The Eurodollar of Chicago Mercantile Exchange contracts rely on three-month US dollar LIBOR rates. These contracts extend up to ten years and they are the most heavily-traded short term interest rate futures contracts in the world. Shorter maturities are traded on the Singapore exchange in Asian time. 

Official Interest Rate – LIBOR Mortgages

LIBOR mortgages are adjustable rate mortgages on which interest rates are based on a specified LIBOR index. Once the rate is fixed during the initial period, it is adjusted to be equal to the most recent value of the official interest rate or the LIBOR index. Then the margin is added subject to adjustment caps, if any.

LIBOR adjustable rate mortgages are developed to meet the requirements of foreign investors who are looking to reduce risks associated with dollar-dominated investments. A foreign bank that purchases the six-month official interest rate or LIBOR adjustable rate mortgages can borrow required funds in the inter-bank market for six months.

 

 


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