Savers have no right to expect an inflation-beating return
Jeremy Warner
5 min read
Bank of England
Easy peasy, most of us said when the Prime Minister set five targets for answering the concerns of voters earlier this year. He might as well have said he aimed to walk a mile in under an hour.
Well, now at least three of what seemed at the time to be some distinctly unchallenging goals – reduced NHS waiting lists, dealing with small boat crossings and getting inflation down – look to be in some danger.
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NHS waiting lists last week hit new records, the legislation to address small boat crossings is plainly in difficulty, and if the latest Bank of England projections are to be believed, then the objective of halving inflation by the end of the year might not be met either.
Bank forecasts don't, admittedly, have to be taken too seriously these days. Just three months ago, it was projecting two years of economic contraction; today, it looks forward to two years of growth, albeit of the very weak variety.
A penny to a pound, there is at least one more increase in Bank Rate to come before policymakers get fully on top of the problem.
As it is, the monetary tightening so far applied seems to have had surprisingly little impact on the economy at large. The labour market remains extraordinarily tight, consumption is holding up well, private sector wages are rising at the rate of more than 7pc per annum, and in nominal terms, house prices have barely fallen since their August peak.
Part of the explanation is that the great bulk of mortgage holders are on low-rate, fixed-rate deals, many of which have yet to expire; indeed, the Bank of England estimates that only a third of its monetary tightening has so far fed through into the real economy.
Sadly, the same is not true of so-called “sight deposits” – deposits that can be withdrawn from a bank at very short notice. At any one time, there is around £350bn of such money sloshing around in current and other instant access accounts, or around 60pc of all household deposits.
Even if left with the Bank of England as reserves, this mammoth float of cash would yield nearly £16bn a year in interest - yet little if any of this is passed on to whom the money belongs. If it was, then it might make a significant difference to consumption.
This absence of pass-through is the cause of growing populist condemnation, with banks accused of profiteering at the expense of hard pressed households faced with an acute cost of living crisis.
Bank of England analysis finds that virtually all the increase in Bank Rate since it began its upward trajectory in November 2021 has been passed on in the form of higher mortgage and corporate lending rates.
The cost of a typical two-year fixed-rate mortgage, for instance, has risen by 3.22 percentage points to 4.76pc. Likewise the cost of corporate borrowing, which tends to be overwhelmingly variable rate and in aggregate has risen by 3.71 percentage points to 5.76pc.
Interest paid on instant access deposits, by contrast, has risen by just 1.42 percentage points on average to as little as 1.53pc. As for money held in current accounts, you'd still be lucky to get anything at all.
The Commons Treasury select committee has been on the case for some months now, and last week wrote again to banks demanding an explanation.
Well, here's what I imagine they'll say:
Let's have a bit of perspective. Ever since the financial crisis more than a decade ago, we've struggled to make any profit at all, with the net margin between deposit and lending rates unusually compressed and returns at well below the cost of capital.
Providing current account banking is not cost-free, yet we don't charge for it, unlike many banks on the Continent. Looking at 150 years of banking history, moreover, the spread has averaged around 2pc. Today it has admittedly been stretched out to about 3pc, but you would expect it to sink back to its historic trend over time.
The prior period of virtually no spread was, in other words, anomalous. Given that this margin is central to most banking business models, it would be unreasonable to demand a permanent stage of no spread at all.
True, banks have somehow managed to get by without much of one for some time now, while still paying senior employees mouth-watering sums of money. Yet banks are in most cases also trading at way below book value on stock markets. Widely seen as uninvestable, they have for many years now been unable to earn their cost of equity.
This possibly doesn't matter as long as the system remains solvent, but if denied the ability to make a profit, it matters a lot in a crisis. If no one will invest, then taxpayers might be called on to fill the shortfall instead.
To explain is not to justify. Lack of interest on current account money has long been a vocal and entirely reasonable source of complaint. But nor is it an open-and-shut argument. As far as term deposits are concerned, where savers lock in their money for a fixed period of time, there has indeed been near full pass-through from higher official rates. One-year money can for instance now pay more than 4pc.
Incentives for term deposits have become relatively more important since the recent spate of bank runs in the United States, where once venerable names such as First Republic have been driven to the wall by a sudden withdrawal of instant access money.
Banks are happy to pay a somewhat higher interest rate for longer term money if it means a slightly easier ride from regulators on liquidity requirements.
Seemingly profiteering banks and corporations make easy targets in a cost of living squeeze, but things are never quite as cut and dried as they seem. You might expect corporate profits to be soaring if the widely held belief that firms have been feeding inflation with unjustifiable price increases were true. Yet in aggregate, their share of GDP has barely moved.
Similarly, banks have to be allowed to make a return; if the price of political pressure for higher rates of interest on sight deposits is even higher mortgage rates, then from a social perspective, it's not such a great outcome either.
