Money Moves Markets

Reflecting fears of financial meltdown, UK savers withdrew cash from bank and building society accounts at a record pace in October. According to Bank of England data published today, households’ M4 money holdings fell by £5.2 billion, compared with an average rise of £5.6 billion over the prior 12 months. The cash withdrawn from banks appears to have been reinvested mainly in National Savings products and Treasury bills, which attracted £4.7 billion and £12.3 billion respectively – also records.

Other key features of the detailed monetary data for October include:

M4 excluding money holdings of financial corporations slowed to an annual growth rate of 3.6% – the lowest since 1993.

In addition to the decline in household deposits, M4 holdings of non-financial private corporations fell again, to stand 5.2% lower than a year before. This suggests ongoing severe pressure on profits – likely to be reflected in significant cuts in jobs and investment.

Consistent with anecdotal evidence of a reduction in credit availability, bank borrowing by non-financial corporations grew at an annualised rate of just 2.4% in the three months to October, compared with a 10.7% rise in the prior year.

Narrow money M1 – currency plus instant-access deposits – fell by 1.8% in the year to October, the largest annual decline since 1969. This compares unfavourably with recent trends in the US and Euroland, where M1 has been picking up.

Banks replaced traditional interbank loans with purchases of bills issued by other banks and backed by the government under the Credit Guarantee Scheme. Market loans to other banks fell by £34.2 billion in October, while purchases of bank bills soared to £17.5 billion.

The estimated spread between the average interest rate received on banks’ and building societies’ M4 lending and the rate paid on M4 deposit liabilities – a proxy for their net interest margin – fell slightly to a new low. Banks need a wider margin to enable them to rebuild capital to support higher lending.

The monetary data confirm a grim near-term economic outlook and warrant a further rate cut at this week’s MPC meeting. However, calls for Bank rate to fall quickly to 1% or even lower are questionable. Considerable stimulus is already in the pipeline in the form of the 2 percentage point reduction since September, a 17% fall in sterling's effective rate over the last year and a projected rise in cyclically-adjusted public borrowing of 4.3% of GDP in 2008-09 and 2009-10 combined. The authorities’ efforts should now focus on improving the transmission mechanism and taking direct action to lift money and credit growth. Specifically, the Debt Management Office could fund the deficit partly by borrowing from banks, boosting M4, while the Bank of England could emulate the Fed by buying commercial paper and mortgage-backed securities, thereby easing credit supply.