Higher mortgage rates threatened: Largest monthly outflow since 1986 as investors withdraw pounds 404m more from societies than they put in

THE BIGGEST haemorrhage of funds from building societies in seven years yesterday raised the spectre of higher mortgage rates, while weak bank lending figures cast further doubt on the strength of the economic recovery.

Investors withdrew pounds 404m more from their building society accounts than they handed over in new deposits last month, the largest outflow since September 1986, according to the Building Societies Association. This was the fourth net monthly outflow in succession.

John Wriglesworth, housing analyst at UBS, warned that building societies might have to raise their savings rates to stem the flow of withdrawals. This in turn would imply higher mortgage rates.

'This absolutely rules out any chance of a mortgage rate reduction in the future if, as expected, base rates come down', he added.

Halifax Building Society said it was too early to say if it would be able to pass on another cut in base rates to mortgage holders, but it did not expect any difficulty funding greater demand for loans.

Low interest rates have encouraged savers to move their money out of building societies in pursuit of higher returns. Savers may also have withdrawn cash to pre-pay their gas and electricity bills ahead of next month's imposition of VAT on domestic fuel and to make the second instalment of payments for the BT3 share issue.

Many elderly savers have moved money into the new Pensioners' Guaranteed Income Bonds, which attracted nearly pounds 500m last month by offering a fixed rate of interest for five years.

A spokesman for the Household Mortgage Corporation said the outflow of savings would put the Treasury under increasing pressure to lift limits on the amount building societies can raise from the wholesale money market to finance mortgages.

Unlike banks and other specialist lenders, building societies are legally allowed to raise only 40 per cent of their funds from the money markets, although in practice they are restricted to 25-30 per cent.

The BSA also reported a sharp rise in net new mortgage commitments from pounds 1.8bn in January to pounds 2.9bn in February.

'The recent evidence that house prices have stabilised and are in fact showing signs of strengthening should help support activity in the run-up to Easter,' said Adrian Coles, director-general of the BSA. But he added that next month's tax increases could slow the housing market revival as people adjusted to the cut in their take-home pay.

Lending by banks and building societies was unexpectedly subdued at pounds 600m in February, up from just pounds 100m in the previous month, according to the Bank of England.

The City had forecast that February's rise in lending would be about pounds 1.8bn. Companies remain reluctant to borrow from banks, preferring to use retained profits and money raised through debt and share issues. Manufacturing industry repaid pounds 245m of debt in February, down from a pounds 267m repayment in the same month a year earlier.

The British Bankers Association said that lending by the leading bank groups fell by pounds 244m in February following a rise of pounds 652m in January. The fall was largely the result of a near pounds 2bn repayment Exchange moneybrokers and market-makers in the gilts market.

Lending to consumers remained weak, rising by just pounds 38m, less than half the previous month's increase. Some pounds 27m of this was accounted for by increased borrowing on credit cards. The rise in mortgage lending was little changed on the previous month at pounds 562m.

The broad measure of money supply M4 - cash plus bank and building society accounts - rose by nearly 1 per cent in February, taking the annual rate of increase to 5.9 per cent from 5.5 per cent in the preceding month. M4 growth is now higher than at any time for more than two years and near the middle of the Treasury's 3-9 per cent 'monitoring range'.

But analysts said M4 acceleration was less likely to herald accelerating growth and rising inflation than if it were accompanied by similarly rapid growth in credit.