Here Richard Murphy points out that a rise in Bank Rate would lead to a rise in margins. This is a fair argument.
Indeed, the main reason why MPC decided not to cut rates closer to the zero floor in March 2009, a view it held to until February this year, was that further cuts would eat into bank profits. This was undesirable because it would either destabilise some institutions, or simply cause them to raise rates on some of their products. The reason for this view was that banks had sold tracker rate mortgages which fell as Bank Rate fell, yet interest rates on deposits were, naturally, bounded at zero. In theory banks could have charged for deposits in other ways, but that was likely to be politically awkward. Some falling mortgage rates and constant deposit rates meant lower margins.
My view was that it was not a good idea to mix interest rate policy – which works not simply through banks – with what at that point was a retail bank financial stability policy. Rates should have been cut lower, and offsetting policies, where they were justified on systemic grounds, contemplated. [In truth, it wasn’t really ‘my’ view, but one formed by talking to a couple of other clever people at the time who can’t be named].
But, likewise, just as I thought rates should have set this consideration aside on the way down, I don’t think interest rate rises should be delayed on the grounds that they may cause this mechanism to go in reverse. There many reasons not to raise rates now, but this isn’t one of them.
In fact, one might see this simply as the unwinding of a distortion on bank balance sheets cause by the need for super low interest rates for macroeconomic reasons.
There is a broader question about why banks expose themselves in this way. Presumably, it was simply because, like the rest of us [and the Treasury included, who set the 2 per cent inflation target] no-one forecast zero Bank Rate would ever be necessary. The hope would be that either banks learn their lesson; or some action [like raising the inflation target at some point] was taken to lower the chance of a zero bound episode. Or some regulatory intervention to prevent exposure to zero rates is considered. Or, perhaps all three.
There’s also an issue for competition policy, of course, in figuring out whether margins averaged over the cycle are bloated. But, once again, that’s not something to address with the instrument we use to achieve the inflation target.