Commenting, he said: “UK banks' net interest margin - the spread between their average lending and deposit rates - remained close to its historical low in January, according to estimates derived from Bank of England data published yesterday.
“The spread stood at 2.08%, little changed from 2.09% in September before the MPC began slashing Bank rate and well below its average of 2.77% over 1999-2008.
”Some commentators accuse banks of widening margins by increasing the spread between lending rates and Bank rate for new and refinancing borrowers. The effect, however, has been offset by a rise in deposit rates relative to Bank rate. For example, the spread between Bank rate and the average rate paid on interest-bearing sight (i.e. instant access) deposits from households fell to just 0.47% in January versus an average of 2.20% over 1999-2008. In effect, banks have been forced to charge new borrowers more in order to keep deposit rates high enough to retain funds.
”The sight deposit rate stood at just 1.14% in January, a level that does not fully reflect the 0.5 percentage point reduction in Bank rate to 1.5% at the start of the month. The MPC cut by a further 0.5 pp in February and the consensus expects another 0.5 pp this week. If so, banks are likely to lower sight deposit rates to almost zero but may fail to prevent a further erosion of their profitability, while running the risk of prompting an outflow of funds, particularly in favour of liquid National Savings products and Northern Rock (both offering an explicit unlimited government guarantee).
”The MPC discussed possible adverse effects of a further Bank rate cut at the February meeting. It said: “There was a great deal of uncertainty about what would happen to banks' and building societies' willingness to lend at low levels of interest rates. It was possible that the negative impact on profitability could be significant for some banks as Bank rate fell further. Taking that into account, a majority of members concluded that a cut of 50 basis points was appropriate this month."
If a Bank rate no lower than 1% was judged appropriate last month, despite the MPC's forecast of a significant inflation undershoot over the medium term, it is difficult to understand why a majority would vote for a cut this week. Contrary to popular assertion, there is no technical requirement to reduce Bank rate towards zero before embarking on asset purchases designed to boost the money supply.”
