The difference between the LIBOR rate and the overnight index swap (OIS) rate is another measure of credit market stress.
When the European LIBOR-OIS spread is increasing, it indicates that banks believe the other banks they are lending to have a higher risk of defaulting on the loans so they are charging a higher interest rate to offset this risk. The opposite applies to a narrowing European LIBOR-OIS spread.
As shown below, the movement in the European LIBOR-OIS spread over the past few weeks is similar to the European TED spread and indicates that confidence in interbank lending has started improving, but the European LIBOR-OIS spread needs to show a more meaningful decline in order for a calmer environment to prevail.
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