Lending to businesses is still weak, warns Bank of England

Report casts doubt on whether 'quantitative easing' policy is working

In a blow to official attempts to boost the supply of lending to British businesses, the Bank of England said yesterday that the supply of credit to companies contracted in May for a second month in a row. The Bank also released estimates on the growth in the money supply (M4) and the trends of lending across the economy that, economists said, also cast doubt on the efficacy of the Bank's policy of "quantitative easing", known colloquially as "printing money".

In its latest "Trends in Lending" report, the Bank said funds raised by businesses from banks and capital markets "remained weak". Disappointingly too, the Bank confirmed the popular view that commercial banks were raising fees and spreads as they attempted to rebuilt their own profitability and capital position, but at the expense of the wider economy.

The inter-bank lending rate (Libor) has recently fallen to exceptionally low levels, but mortgage rates and the cost of loans to businesses have been creeping higher, with banks pinning the blame on the increasing cost of bad debts. The Bank of England report said: "One factor that lenders have cited for the upward pressure of spreads over Libor or Bank rate has been the difficulty and expense of longer-tern funding. Funding conditions for lenders have eased slightly over the past three months, moderating somewhat that influence on spreads.

"Lenders continued to report that defaults and losses on loans to companies have increased and were expected to rise further. This deterioration ... has caused lenders to widen spreads."

Commercial banks effectively sucked £3.4bn out of the corporate sector in May, on top of a £6bn contraction in April. This compares with the normal expansion of lending of £7bn per month during 2007 and £4bn even in 2008, when the credit crunch was well under way. Tellingly, too, the bank said there was little evidence of rising demand for credit from companies, suggesting the demand for working capital was very depressed. Foreign lenders, or the absence of them, accounts for most of the decline; little seems to have come form the "lending agreements" agreed between the Government and the major banking groups as a condition for recapitalisation and other support. More optimistically, the big banks indicated some stabilisation in their economic outlook, and predicted a rise in demand for loans in the coming months.

Meanwhile, Bank of England said M4 money supply grew by a mere 0.2 per cent month-on-month in June. This was better than some recent negative months, but was attacked as inadequate by some City analysts. Vicky Redwood, of Capital Economics, said: "The broad monetary aggregates are still showing little sign of responding to the Bank of England's quantitative easing programme. We therefore continue to doubt the quantitative easing undertaken so far will ensure a strong economic recovery.

"The Monetary Policy Committee has now bought more than £115bn of the £125bn of assets it has voted to purchase in total, and the remainder should be completed by the start of August. The upshot is that even though the MPC will soon have pumped the equivalent of some 8 per cent of GDP into the economy, an even bigger stimulus seems to be required."

There seems to be a growing consensus in the City that the Bank of England will indeed expand its quantitative easing programme at next month's MPC meeting, or perhaps later in the year after a "pause" to consider the effectiveness of the scheme. The first tentative litmus test of the policy and the state of the economy comes on Friday when Q2 GDP figures are released. Most analysts expect another drip on national income, though a much smaller one than the record quarterly slump of 2.4 per cent in the first three months of this year.