Will the Recent Fall in Cash Rates Finally Kickstart the Healing Process?

By Stephen Black (Managing Director at Tier One Capital) 18 December 2012

Whether to rejoice or cry at the recent introduction of the Funding for Lending (FFL) Scheme by the Bank of England is a matter of perspective. From a stability perspective, it's clearly a good thing to know that the necessary underlying support is explicitly there for financial institutions which are undoubtedly still carrying a huge amount of legacy bad debt. A run on a bank does no part of the economy any good and the FFL scheme creates another barrier to this happening again in the near future by offering a virtual solidification of each individual company's balance sheet.

From a lenders perspective, whilst it will be some time before the true effects and/or success of the scheme will be known, the Bank of England's latest bulletin suggests that the first signs are there that it is finally starting to slowly turn the tide to stimulate lending in the UK economy. If true, and it's a big if, this is again good news for virtually all parts of the UK economy. Why? Because the two areas of any economy which need constant lending support are firstly the housing market and secondly the mass of small to medium enterprises. Both have been starved of this support since the onset of the credit crunch and the lack of support to the latter is especially concerning as it is from the small to medium enterprises of yesterday that the stellar performers of today emerge to inject much needed growth. Ultimately, as it is growth that will beat the beast of the credit crunch rather than austerity, this light at the end of the tunnel is most appealing. So where's the downside then?

The downside of all this is that those forgotten souls classed as savers have been dramatically hit by the FFL scheme. The very support that is a good thing from a stability perspective means the banks do not harbour as much fear that they will run short of liquidity. In turn, this means they do not have as much of a need to attract cash and, finally, if they do not need to attract as much cash then they can offer lower rates and attract fewer depositors accordingly. As savers have already been subjected to historically low cash rates, the market-wide depression of cash rates across all institutions by a good 0.5% to 0.75% is a particularly bitter pill to swallow.

Cash portfolios constructed of market leading rates are now averaging around 2.5%-2.8% with a good balance of liquidity. This compares to around 3%-3.3% only eight weeks ago and is quite a massive percentage decline from an already abnormally low level. The positives? The sooner lending genuinely begins once more, the sooner the economy can begin to normalise. For savers dreaming of a return to the good old days of 6%-7% rates pre-credit crunch, this is an important first step in a long journey ahead.