The recent rise in interbank interest rates reflects a clash between expanding bank funding needs and a fixed level of longer-term Bank of England lending against private sector collateral – see yesterday’s post.

The pressure may, however, have been aggravated by a flow of cash back to Northern Rock .

Other banks benefited from Northern Rock’s woes last autumn, as savers withdrew funds from the troubled lender and redeposited them elsewhere. Now, the reverse flow is occurring, with savers lured back by attractive rates and government guarantees and Rock’s mortgage borrowers encouraged to refinance with other lenders.

Rather than lend its surplus cash back to other banks in the interbank market, Rock has reduced its borrowing from the Bank of England . The Bank of England weekly Return suggests the Rock loan has fallen from a peak of £27 billion in January to £21 billion currently.

The Bank of England should increase longer-term lending to the market to offset the liquidity drain from Northern Rock.