UK government scheme fails to boost lending in first month

The Telegraph reports that the latest UK government scheme failed to boost lending in its first month.  In fact, lending contracted as borrowers repaid their existing debts.

Regular readers are not surprise that the UK government is having trouble boosting lending.  It is fighting against zero interest rate and quantitative easing policies.

One unintended consequence of zero interest rate and quantitative easing policies is that it changes the definition of the risk free rate.

Clearly, if the rates on government debt are being artificially lowered, these rates are not risk free.  As a result, there is a search for an interest rate that is risk free.

For anyone with a loan outstanding, the risk free rate becomes the rate they pay to borrow.  Any money they use to pay down the outstanding loan generates a return equal to the rate on the loan.

If you borrow at 5% and can only invest excess cash at 0.10%, it makes sense to 'invest' the excess cash in paying down the loan as it 'saves' the borrower 4.9% (the difference between the borrowing rate of 5% and the investment rate of 0.10%).

Attempts by the authorities to boost the supply of credit have failed in the first month of trying, economists said, after official data showed that borrowers repaid their debts last month and rates continued to rise. 

In the first full month that the Funding for Lending Scheme (FLS) was operating, households repaid £276m of mortgage debt and cleared another £134m of personal loans. Lending to businesses dropped by £2.2bn, the largest monthly decline since February. 

The figures, from the Bank of England, also showed that the average fixed mortgage rate rose by 0.03 percentage points in August and is now 0.52 percentage points higher than at the start of the year. 

Michael Saunders, UK economist at Citi, said: “The data suggest that the introduction of the FLS has not produced significant immediate results in improving the growth or price of credit to households and businesses.” 

The Bank and the Treasury launched FLS, which provides banks state-backed low-cost funding, on August 1 in an attempt reduce borrowing costs for households and businesses and increase lending. ... 

However, the Bank’s data suggest that there is little demand for credit currently, which would limit the impact the scheme would have on restoring economic growth....

“The Bank of England data indicate that consumers appetite for new taking on new borrowing is limited while there is also an ongoing strong desire of many consumers to reduce their debt,” Howard Archer, IHS Global Insight UK economist, said.