What Is LIBOR in the Stock Market?
LIBOR, the London Interbank Offered Rate, is the interest rate that banks offer other banks on the London financial market, which is used by many of the world's largest borrowers. LIBOR is not part of the stock market or directly related to it. However, it does affect stocks in the United Kingdom, the United States, and many other countries.
LIBOR is generally seen as the international benchmark for short-term interest rates; in the U.S. financial market the federal funds rate fulfills a similar function. LIBOR is calculated daily by Thomson Reuters in association with the British Bankers' Association, based on rates from a survey of 16 banks. Because LIBOR is the rate that banks use to lend to each other, it is considered a good indicator of the direction of interest rates as a whole.
Relationship Between Interest Rates and Stocks
In general, when interest rates go up, stock prices go down. This is because investors can get a better rate of return on bonds, and with lower risk, so they move money out of stocks and into bonds. When interest rates go down, stock prices go up as investors move money from bonds into stocks because the return on bonds has fallen. In more indirect ways, higher interest rates can drive stocks lower because the increased difficulty of borrowing funds inhibits growth. Raising interest rates on consumers makes carrying debt more expensive for them, which hurts their confidence and curbs spending.
Relationship Between LIBOR and the Stock Market
Because LIBOR is an indicator of interest rates overall, as LIBOR decreases, stocks prices in general should go up. As LIBOR increases, stocks should go down. However, at any given time many factors affect international financial markets. So although a lower LIBOR should lower interest rates and drive UK stocks higher, other market factors might keep it from doing so in the United States or Japan.
In 2012, at least 16 global banks were accused of suppressing LIBOR in the years around the financial crisis in 2008. In June 2012, UK-based Barclays bank agreed to pay $450 million to settle charges by British and U.S. authorities that it helped rig the LIBOR. It is difficult to know how individual investors were affected by the alleged LIBOR rigging, However, consumers who invested in financial securities with returns tied to LIBOR might have received lower returns than they would have with an unsuppressed rate. Other consumers might have benefited by getting lower rates on loans because of a suppressed LIBOR.
Based in Chicago, Charles Grant has been writing about money since 2005. He also serves as a financial manager and consultant. Grant received his Bachelor of Science in finance from the University of Illinois at Chicago.