Monday, December 23, 2013

Watch The Savers...

Almost un-noticed came the announcement from the Bank of England that long-term savings had dropped by £23 billion in the year to October 2013 - a drop of 4.7%, the last time there was a yearly percentage drop of that magnitude Ted Heath was in Downing Street. In absolute terms, we've never seen such a big drop.

That reversed the trend from October 2007 to October 2012, when savings had increased each year.

So what caused the change and why is it important?

In July 2012, George Osborne launched the Funding for Lending scheme, whereby banks and building societies could borrow from the Bank of England for four years at rates significantly cheaper than market rates. The intention was to get the banks to lend - but Osborne was too inexperienced/naive/stupid/take your pick, to understand he was dealing with bankers, who simply saw the opportunity to increase their margins. They promptly lowered the already abysmal rates they paid their savers - why bother to go to the expense of attracting savers when you could fill your boots with very cheap rates from the Bank of England?

Then on 7th August 2013, Mark Carney, in his first statement as Chairman of the Bank of England, issued forward guidance, stating flatly that

In particular, the MPC intends not to raise Bank Rate from its current level of 0.5% at least until the Labour Force Survey headline measure of the unemployment rate has fallen to a threshold of 7%
They also announced they would not even consider stopping QE till unemployment had fallen to 7%.

Funding for Lending and Carney's statement shattered the tense equilibrium between savers and borrowers, where borrowers, nervous about rising interest rates should the economy recover, tried to continue to pay down debt and savers, hoping for rate rises if the economy recovered, gritted their teeth and held on.

Not only did savings fall, but there was a record rise in borrowing, according to Bank of England figures. Household debt is the highest since September 2008.

Clearly the figures shocked Carney, because on 28th November 2013, Carney announced that he was withdrawing Funding for Lending for Mortgages.  However there is no sign that lenders have increased savings rates in response - and add to the mix that the govt introduced Help to Buy for all properties on October 2013, where the govt takes on 15% of the risk of the mortgage should a default occur.

Why does all of this matter? Banks can only lend if they have funding - and funding comes from two areas - savers and the money markets. Add in a third source in the form of the Central Bank, in schemes like Funding for Lending.

Savers are now on strike thanks to the Forward Guidance, and their abuse from the banks punch happy on Funding for Lending. So the banks are funding mortgage and other lending via the money markets.

That's the Northern Rock business model. Northern Rock if you remember, thought that other banks and building societies were foolish maintaining expensive branch networks in order to attract savers. They'd be smart and borrow cheaply from the money markets instead. And they made spectacular profits till the money markets froze in 2007 and Northern Rock got stuffed.

But despite the lessons of 2007/8 we have the more of the banking industry dependant on the money markets than before.

The BoE will have to do something to attract savers back - possibly an interest rate rise in 2014. In the meanwhile hope and pray the money markets don't freeze up again...