Inflation in the UK is officially supposed to be about 5% and thus is the highest among the developed economies who founded the G7. Despite this our Bank of England ‘Base Rate’ has for nearly 3 years been  0.5 % – one of the very lowest in the developed world and lower than that of  the Eurozone.

But in the real world,  borrowers in the UK are paying some of the highest interest rates in the developed world. We have highlighted this in previous reports and the chart (left) brings together some most recent comparable figures assembled by all Europe’s central banks and contributed to the ECB Data Warehouse.

We have compared the UK figures here with the Eurozone leaders and some of the countries in distress. The rate for savings is based on deposits that are only tied up for three months and the rate for loans is based on loans for house purchase based on a term of  at least 5 years .  So the savings rate is the one that would be appropriate to new and modest savers, and the housing rate is one of the most used in the UK given how much borrowing (even for business) is based on using houses as security.

With savings rates being so unattractive, there is little incentive to keep any savings in the UK. For example UK pensioners in Europe would get a better rate of return in keeping as much of their pensions as possible in accounts on the continent rather than leaving them in their UK £ accounts. Businesses would get an even better return on cash balances on the continent.

Hence the Pound, which has fallen by 20% since the credit crunch, has had no upward pressure on it since the time the very lowest of interest rates has been officially justified. This devaluation has exaggerated price increases in the UK. However, we have argued in earlier reports that devaluation has not and cannot now do much for employment in exporting industries.

Interest rate adjustment for 2012

Hence we now think that the government and the Bank of England should change the way they give guidance to the banks in setting interest rates. The Bank of England should now be recommending a savings rate of about 2% and maybe a lending rate based on 4%. They should discard the fictional rate of 0.5%. This would boost the £, and therefore bear down on inflation. But it would also safeguard domestic purchasing power and give a much needed boost to confidence.

Another variant would perhaps be not to recommend a drop in lending rates, but to suggest that the banks adopt a distress rate of 4% for individuals and sectors in difficulty. The banks could be told to come back with proposals for applying this first in the regions that are experiencing particular difficulties.

In the current crisis the West Midlands, where we are based, has suffered some of the worst increases in unemployment, especially for young people. This is a distress that is not evenly spread across the UK. Scotland for example has even seen unemployment fall in 2011. So the Bank of England could ask that the banks report on the credit situation in the Midlands.  This would be like the scrutiny regularly undertaken by the US Federal Reserve, who publish what is called the Beige Book, consisting of feedback from the local economies across the whole USA. Initiating such open assessments would allow the consideration of  distress arrangements that might be appropriate, as an initial step towards stability and relief in 2012.

Where the money is to be found

It can be seen that the UK banks are adding a stunning mark-up to the money they are lending. This mark-up cannot be justified in the current circumstances. Based on the rates presented in the chart above, the mark-up in the UK is roughly 700%. This is far higher than in any of the other countries in the chart. Their mark-ups on the same calculation would be:

Germany      200%

Greece        200%

France          80%

Ireland          40%

This scale of mark-up has only been occurring during our years of crisis. Back in 2004 the same calculations show a mark-up in the UK of a mere 64%, which was less than any of the other countries in the comparison. German banks were already marking-up 200% and the others averaged out at 135%.

This recent squeezing of their customers, while it must have done a lot for the profits of  UK banks, has done little for shareholder value.  But above all it has been the basis of the continuation of excessive bonuses for executives. The time has come when the revenues coming into the banking sector have to be adjusted to support savings in a UK that still imports other countries’ savings and also needs to relieve a UK  economy that in some parts is heading back into another recession.

So the time has come for the Bank of England to be more insistent upon its guidance, and get the banks to stop putting themselves first. The money is in their margins to allow this to be done. In 2012 we hope to attract more attention to how we would like to see the Bank of England reformed and made more accountable and responsive to the pressures being felt in the various parts of the UK economy.  We also hope to do this while continuing our long-standing work to change the way inflation is measured and controlled in the UK.

Our last report on inflation undermining consumer confidence and growth can be found here.

Andrew Lydon



Further details of our  Regional Prosperity & Inflation Project