Tumbling rates may bring end to free banking

High Street banks could start charging customers to have accounts in a bid to recoup falling profits related to lower rates.

The Bank of England has cut rates from 5% to an all-time low of 1% since October and was expected to act again today.

Banks make profits through their "interest rate margin" - the difference between their deposit and lending rates which covers the cost of providing a service.

They tend to set deposit rates a little below the official rate set by the Bank. Once deposit rates hit zero, further falls in lending rates reduce profits.

The Bank's monetary policy committee is concerned the lower returns enjoyed by banks will cause them to restrict lending further and starve the economy of much needed credit.

One solution for the banks could be to scrap free banking and charge customers.

"There is a case for bringing down interest rates to zero, or close to zero, as soon as possible to boost the economy," said Howard Archer of Global Insight.

The end to free banking came a step closer last week when Britain's biggest banks lost their appeal against a decision allowing the Office of Fair Trading to decide whether or not charges on unauthorised overdrafts are fair.

The expected cut in interest rates today came as economists at PricewaterhouseCoopers predicted gross domestic product will fall 5% this year - far worse than the Treasury forecast but in tune with thinking at the Bank.

The PwC report predicted the recession will last throughout 2009 and into 2010 as a result of rising unemployment, falling house prices, a lack of credit availability and a collapse in world demand.

"We recommend that businesses should stress-test their plans and valuations against a pessimistic scenario in which GDP falls by around 5% this year followed by a further 2% fall in 2010," said John Hawksworth, head of macroeconomics at PwC.

The Bank has warned the UK could suffer a bout of deflation this year despite its aggressive rate cuts.

The cuts have helped borrowers but caused misery for savers who have seen interest returns plummet.

Just a third of lenders passed on any of last month's cut in interest rates to mortgage holders while almost 80% cut rates for savers.

Shelagh Heffernan, professor of banking and finance at Cass Business School, said further rate cuts could create a backlash from savers.

She added: "As deposit rates fall toward 0%, savers have precious little incentive to keep existing deposits at banks, never mind increasing them."