Soaring UK Inflation Leads To Record Deposit Run

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by Tyler Durden
Monday, Jul 03, 2023 - 11:50 AM

While the US deposit fight that started with the failure of three major US banks in March, has alternated between a bank jog, run and a sprint, depending on whether one uses actual data or the Fed's politically-mandated seasonal adjustments to deposit outflows...

... the rest of the "developed world" has so far avoided a similar cascade of bank failures (who knew that injecting trillions in reserves to artificially preserve bank viability would make them beyond brittle and terminally fragile the moment liquidity was withdrawn) and by extensions, a sweeping bank run.

Or maybe not, because while no other western nation suffered a recent bank crisis as painful as that of the US, it doesn't mean that other nations are immune to deposit flight.

Consider the UK, where households just withdrew a record amount from bank accounts last month; and while in lieu of a bank failure panic that would suggest consumers are looking elsewhere for higher interest rates, the reason why deposits are fleeing banks in the US may have a much simpler reason: tapping savings to pay bills.

As the FT reported, a net £4.6bn was taken out from banks and building societies in May, the highest level of withdrawals since monthly records began in 1997, according to the Bank of England data published on Thursday.

And since the large net withdrawals from instant-access accounts were only partially offset by net inflows into fixed-term accounts, which typically pay higher rates, and individual savings accounts, which offer tax-free dividends and interest on shares or cash, this suggests that the deposit flight wasn't the result of rate arbitrage.

BoE figures showed the effective rate on instant-access accounts dropped 8 basis points to 1.33 per cent in May. That lags considerably both the central bank’s benchmark rate, now at a 15-year high of 5 per cent, and rates for two-year fixed mortgage deals, which are above 6 per cent.

In its latest report, the BoE’s Monetary Policy Committee noted that “the pass-through [of higher interest rates]” to these accounts had “been unusually weak” since it began raising rates in December 2021.

So if not merely moving deposits from Bank A to Bank B, what's going on? According to Ashley Webb, UK economist at consultancy Capital Economics, some of the fall to “people moving money into other investments outside of the banking sector, such as UK gilts”. But he added: “It’s possible that households’ pandemic savings are being depleted to support spending.”

UK households are contending with high inflation, which stood at 8.7% in May, and many have complained that bank savings rates are failing to catch up with the BoE’s rate hikes.  Yields on UK 10-year gilts stand at about 4.3%, up from 3.3% in March, while two-year government bonds have a yield of 5.2% up from 3.2% in March, reflecting the changing outlook for interest rates.

Daniel Mahoney, UK economist at Handelsbanken, said the record £4.6bn figure provided “strong evidence” that people were “dipping into excess savings built up during the pandemic to sustain living standards” amid the cost of living squeeze.

While Charlotte Nixon, mortgage and financial planning expert at Quilter, said bank executives had been under pressure to raise interest rates for savers as they have done for borrowers, she warned that banks had argued that “mortgage rates would need to get pushed even higher for them to still achieve their margins”, in the process forcing savers to pull even more money from banks.

Separately, the BoE figures also showed that net mortgage approvals for house purchases rose to 50,000 in May from 48,690 in the previous month. The number was higher than the 49,700 forecast by economists polled by Reuters but well below the average of 66,000 between 2015 and 2019, as higher mortgage payments hit prospective buyers. The figures, however, do not fully capture the sharp rise in mortgage rates since the end of May, after official data showing stronger than expected wage growth and inflation pushed up interest rate expectations.

Thomas Pugh, economist at the consulting firm RSM UK, said the rise in approvals in May was “likely to be reversed” this month “as the recent surge in mortgage interest rates depresses demand”. He forecast a peak-to-trough decline in house prices of about 10%, “with the risk of bigger falls if interest rates continue to rise”.

Ironically, even with a relatively stable banking system, the UK is already suffering from a surge in deposit outflows merely to offset the crippling stagflation that has gripped the nation. But at this rate, it's only a matter of time before the bank run leads to one or more bank failures, which will only accelerate the deposit flight, lead to more bank failures, and so on as the BOE finds itself in an impossible pickle: keep rising rates to contain inflation or try to break the vicious loop of soaring prices, less savings, and rising bank failures.