If the fortunes of the UK banking sector looked uncertain at the start of 2016, the political shocks during the months that followed have thrown up even more questions for this year. At least there was movement on interest rates: the Federal Reserve raised its core funds target range by 25 basis points for only the second time since before the financial crisis. It has now flagged three further rises this year, spurred by a stronger economy and expectation of president Donald Trump’s inflationary fiscal policies; so-called ‘Trumpflation’.
This has led some to argue that the Bank of England (BoE) will, as usual, follows the Fed’s lead – especially given the domestic outlook for inflation after the devaluation of sterling. This would be good for UK banks, which have had their net interest margins pinched even harder this year following the BoE’s 25 basis point reduction in its core rate, intended to shore up confidence after the Brexit vote.
Lower interest rates suppress the margin that banks can make on long-term loans over the interest they pay on their short-term deposits. In a rising rate environment, they can boost profits by not passing through the higher income to customers straightaway.