What about us savers?

Yesterday's cut in base rate somewhat surprised bankers, who hadn't realised that discussions with the government were over and agreed. The response to the cut has been mixed, with some banks including those partly nationalised indicating that they will not be cutting their lending rates by the full 1% .

The difficulties facing the banks and other lenders are mainly twofold:

1) The bulk of their funds to back lending comes from the wholesale market, that is from other financial institutions. The problem here is that there is so much suspicion and mistrust that their rates (especially Libor) are well above base rate because of present circumstances. These rates are also obdurately refusing to go down with any speed. It is no good the government shouting at the banks and berating their failure to reduce rates greatly.

2) A major reason which has driven lenders into the wholesale market is that personal savings deposits have dried up. Traditionally mortgages have been composed of "small" deposits of many people bundled together to provide mortgages for relatively few. For many years the system worked well and lenders made their profit and covered their costs from the margin between the lower rate they paid depositors and the slightly higher rate they charged borrowers.

The problem has arisen because during the last 10 years we have saved progressively smaller and smaller amounts of our income. On the contrary, we have collectively overspent and accumulated large debts. At the beginning of the Brown/Blair reign the ratio of savings to income was approaching 10%. Now it is about 2%. The result is that progressively lenders have been driven into the wholesale market to borrow money to lend to customers. This was the undoing of Northern Rock.

We now have, to finally reach the title of this post, a situation where the necessary virtue of saving is not being helped, with rates of return at the moment well below the level of inflation in many cases after tax.

The cut in base rate, which the Tories had been advocating and which Brown has adopted, thus sends out an unfortunate message. It discourages saving at a time when it should be maintained or even increased. (Brown could argue, with some justification in the very short run possibly, that businesses which do not pass on his VAT reduction and consumers who receive the benefit from those which do, will discourage extra saving because of its poor return. Against this could be argued that much will merely be put to reducing debts.)

There is another factor. Many savers had put away savings over a number of years, in order to acquire a pot to bring them extra comforts in retirement. In some cases pensions are so poor that this savings pot is vital to supplement their pension. Now it is losing its real (after tax) value. Their pot is losing value and their regular withdrawals of interest will be worth less. They will have to tighten their belts even further, especially the elderly who have faced the highest effective inflation rate over the past 5 years.

So the question is, why should mortgagees be benefited, when they have in some cases gambled beyond their means in an expensive housing market, at the expense of savers? The latter may not lose their home, but many of them rely on savings income. They will be driven into state benefit or else reduce their spending wherever they can, neither of which will help the government's debt problem or recovery. It should be remembered that there are many more savers than borrowers, something like six times as many.

Brown got his headline, and may even succeed in bouncing the banks reluctantly into reducing their income. What effect this will all have in the desire to promote spending and recovery is very unclear.