Risk of stagflation 'unless bank lending picks up'

The British economy is at risk of "stagflation" unless bank lending picks up, a former Liberal Democrat Treasury spokesman has warned.

Lord Oakeshott said that the latest report by the Bank of England's agents, released yesterday, pointed to an economy "still bumping along the bottom with growth invisible to the naked eye outside London".

He added: "With inflation marginally up, there is a real risk of stagflation in 2013 unless we can wrench bank lending and housebuilding up off the floor."

The agents' report said that there was some evidence the Government's Funding for Lending Scheme (FLS) was increasing the availability of mortgages and other types of lending, but said there was "less evidence of traction" in the commercial lending market.

The minutes of the December meeting of the Bank's rate-setting Monetary Policy Committee (MPC) were also released yesterday, and the committee noted that it was "quite likely" the economy would contract during the final quarter of the year, thereby putting Britain at risk of a triple-dip recession.

Despite this, the MPC voted by eight to one to keep the £375bn quantitative easing policy on hold. The MPC saidthat it was "too early" to judge the impact of the FLS, which subsidises the borrowing of banks provided they pass on the savings in cheaper loans.

Over the first two months of the scheme six banks took advantage of £4.4bn of funding, while expanding their loan books by £500m.

But some banks, including the state-owned Royal Bank of Scotland, took FLS funding while simultaneously contracting the amount of money it was lending out. "The problem is that the biggest bank – the Royal Bank of Scotland – is a zombie bank," said Lord Oakeshott.

The Bank of England's Funding for lending scheme could see up to £80bn being injected into the economy with most lenders signed-up.