UK lending indicates transmission failure

Data on Friday showed that the mass of central bank liquidity pumped into the UK financial system is struggling to get out into the "real" economy, suggesting the transmission mechanism of bank credit is still impaired. Net lending to British firms fell in July by the biggest amount since records began in 1998, the Bank of England said, while provisional data showed that broad M4 money supply grew just 0.1 percent in August from the previous month.
Mortgage approvals rose for the seventh straight month but the data suggest that the continued improvement in money market conditions isn't feeding through to the wider economy. The report came out as London interbank lending rates (Libor) for sterling, dollars and euros fell to record lows, and the Libor spread over anticipated central bank policy rates - a measure of market stress - shrank or held at low levels. "There are no real signs that banks are lending out," said Jonathan Loynes, chief European economist at Capital Economics in London, refering to the UK data.
The net flow of lending to UK businesses fell 15.5 billion pounds in July after a 3.6 billion pounds fall in June, the BoE said. London interbank offered rates for three-month sterling funds were fixed on Friday at a new low of 0.58125 percent. The premium for Libor over Overnight Index Swap rates, a measure of money market stress, held at 29 basis points.
That spread was as low as 25 basis points earlier this week, comfortably the lowest since Lehman's implosion. Sterling Libor remains on a downward path after BoE Governor Mervyn King said on Tuesday the Bank could cut the interest rate paid on bank reserves to encourage banks to lend. Two-year UK gilt yields this week hit a historic low around 0.71 percent.
This improvement in money market conditions from their near-death experience after Lehman Brothers collapsed a year ago was highlighted in a report from the European Central Bank late on Thursday. Some in the group of 20 money market experts who contributed to the report said improving market conditions warrant the ECB adding a premium to the rate at which it offers one-year funds at its upcoming tender.
The ECB is expected to alot 125 billion euros of one-year funds at the September 29 tender, about a quarter of what banks took up at the June tender, according to the median estimate of a Reuters poll of 26 money market participants. The forecasts ranged from 50 to 300 billion euros.