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Mortgage lenders have been urged to pass on the cut in Libor rates to their consumers.

Economists warn that more money is set to be taken out of the housing market than is being put back in, which may imply that home prices could go on falling

Has the Bank of England lost its power, to re-work Scotty's famous line from Star Trek?

Last week it cut interest rates by 0.5%, in a coordinated attempt with other central banks to re-stimulate the global economy.

Since then, the LIBOR interest rate charged by banks for lending to each other over three months has barely moved.

And that matters, because banks set their prices for credit provided to households and businesses off that so-called interbank rate.

Or to put it another way, banks aren't passing on to us the full cut in the interest rate which the Bank of England thinks is necessary to prevent a deflationary recession.

This may be particularly frustrating for the Bank of England and the Treasury because they've been doing a sterling job, to coin a phrase, of providing loans and financial support to banks, to make up for the credit that's been withdrawn because of the seizing up of wholesale money markets.

As of yesterday, the authorities had committed - since the start of the credit crunch last August - to provide an incremental £600bn of taxpayer loans and support to our banks.

Which is just a little bit less than the net dependence of our banks on the defunct wholesale markets.

And our banks are likely to get even more financial help from the Bank of England, thanks to imminent reforms announced today of the way it provides them with loans and liquid assets.

Will this do the trick? Will banks start lending more to us and at reduced interest rates?

That's doubtful - and the Bank of England may well be seen as implicated in the way that banks are reducing how much they lend.

How so?

Well, the Bank of England stressed today that all its additional lending to banks is intended only to see them through this time of stress - and that this financial support should not be seen as a source of longer term funding to the banking system.

So if our poor battered banks don't expect a recovery in wholesale markets any time soon - and it would be foolishly Micawberish of them to count on such a recovery - then they have no option but to reduce what they lend to businesses and to individuals.

Which is why it will be very difficult to turn our super-tanker of an economy away from recession.

Following a decision by the Bank of England to cut the Base Rate, Nationwide Building Society has announced that it will decrease its Base Mortgage Rate (BMR) from 1 November 2008. The BMR will decrease by 0.30% from 6.49% to 6.19%, making it the lowest on the high street. Nationwide said that it’s ‘reflects Nationwide’s continuing [...]

After the Governments of Europe and the US announced bailout packages for its banks this week, it has emerged that Libor, the rate at which banks lend to one another, has fallen slightly. Libor fell from 6.249% to 6.21%, marking a significant shift and providing some much-needed good news for the UK mortgage market. The fall [...]

The rate on 3-month Libor has fallen 27 basis points over the last two days -- that's the biggest drop since the Federal Reserve saved Bear Stearns from bankruptcy in March -- and the TED spread has also fallen over the last four sessions. Are these signs that credit markets are thawing?

JP Morgan's Alex Roever says the equity injection program wasn't "a panacea for money markets or Libor" partly because both the supply and demand for interbank lending will be light as long as banks are worried about runs. That means holding onto funds will be of greater import than lending them out. But, overtime, funding pressures should likely ease, Roever said.

Most other analyst comments echoed the sentiment that the recapitalizaiton announcement would be the first step in a long unfreezing process.

But it's surprising that Libor hasn't fallen more, largely because the FDIC has guaranteed interbank lending free-of-charge for the next thirty days. And another measure of bank stress, the spread between Libor and Overnight Index Swaps, actually expanded today to 3.44 percent from 3.42 percent yesterday after falling for three straight sessions. (I don't want to put out a stat and immediately negate it, but it's also important to note that in a world where banks can get short-term money readily from the Fed, Libor loses some of its appeal as an indiciator of funding costs.)

With about $300 trillion worth of contracts dependent on Libor (that's $45,000 for every human being on the planet) and with the vast majority -- like mortgage interest rate resets and non-financial corporate funding -- not having anything to do with interbank lending, it's clear that Libor is massively important for the entire economy.

So what else can be done reduce short-term rates to historical norms?

Lou Crandall at Wrightson-ICAP points out that higher rates aren't just a signal of counterparty risk aversion, but also of an appetite for liquidity:

All sorts of market participants, from corporate cash managers to financial intermediaries, are scrambling to avoid the risk of being caught in a liquidity squeeze, which gives them a strong preference for overnight maturities.  Heightened concerns about counterparty risk may have been the major reason for the initial pullback from the term money markets last month, but investors' worries about their own liquidity exposure could make them slow to extend back out the curve even though the bank safety net has been strengthened.

And since there is no explicit method in the Treasury's recapitalization plan to force banks to restart interbank lending, other measures may need to be created if, despite Paulson's proclamation, Libor remains high. Crandall proposes one potential measure to tackle the supply issue: the creation of a bankers' bank by the Fed that would give short-term deposits to sounds banks in countries that had created solid safety-nets for their financial systems.

The Fed will wait for a while before trying anything radically new like this, but only for so long:

If LIBOR-OIS spreads don't start moving back toward pre-Lehman levels by the end of this month...the Fed may have to consider the creation of a new market entity to pull rate levels down.

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The Chancellor and Treasury have sought to clarify proposals calling for HBOS, Lloyds TSB and Royal Bank of Scotland (RBS) to resume lending to homeowners and small businesses “at 2007 levels”.

James Charles, Times Online - 14 Oct 2008

In the House of Commons today the Alistair Darling said that there had been a “misunderstanding” in relation to the Treasury plan, which was announced this morning following the Government’s £37 billion bail-out of the three banks.

The Council of Mortgage Lending (CML) was quick to condemn the original proposals, which included a reference to “maintaining, over the next three years…competitively-priced lending to homeowners and to small businesses at 2007 levels”. The CML said that such a goal was “not prudent” and that it was “very unlikely that we will see lending return to 2007 levels in the near-future.”

But the Chancellor and Treasury have since attempted to calm the dispute. The Treasury told Times Online that the original statement released this morning was making a general point about the desire to ensure that there was a broad range of mortgages available, in general, across the mortgage market. Full Article

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AIB has announced that it will no longer offer Tracker Mortgages to new mortgage applicants, effective from close of business on Friday 10th October 2008. In a press release on Friday afternoon, AIB said that the Tracker Mortgage product has been under review because of the continuing high cost of funds in the market. Tracker Mortgages [...]

Woolwich is cutting its standard variable rate (SVR) by 0.5 per cent following the announcement that the Bank of England base rate will fall by 0.5 per cent. As well as the cut in SVR, all customers on base rate trackers will also see their rates cut by 0.5 per cent with effect from 1st November. [...]