ICAEW chart of the week: Inflation

My chart for ICAEW this week illustrates how core inflation has only dropped from 6.3% in December 2022 to 5.1% in December 2023, even as the headline rate has come down from 10.5% to 4.0%.

Two step charts under the title 'Inflation'.

Step chart 1: 2022
(12 months to Dec 2022)

Core inflation +6.3% (corresponding to 5.0% in height)
+ Food prices +16.8% (height 1.8%)
+ Alcohol & tobacco +3.7% (height 0.2%)
+ Energy prices +52.8% (height 3.5%)

= CPI all items +10.5% (height 10.5%)

Step chart 2: 2023
(12 months to Dec 2023)

Core inflation +5.51% (height 4.0%)
+ Food prices +8.0% (height 0.9%)
+ Alcohol & tobacco +12.9% (height 0.5%)
+ Energy prices -17.3% (height -1.4%)

= CPI all items +4.0% (height 4.0%)


18 Jan 2024.
Chart by Martin Wheatcroft FCA. Design by Sunday.
Source: ONS, 'Consumer price inflation, UK: Dec 2023'.

(c) ICAEW 2024

On 17 January 2023, the Office for National Statistics (ONS) published its latest consumer price inflation (CPI) statistics for the 12 months to December 2023, reporting that headline inflation has fallen to an annual rate of 4.0% compared with 10.5% a year earlier – a more than halving of the annual rate of price growth.

This contrasts with CPI excluding energy, food, alcohol and tobacco (typically described as core inflation), which was 6.3% and 5.1% in the 12 months to December 2022 and 2023 respectively.

The left-hand side of my chart this week illustrates how core inflation in the 12 months to December 2022 of 6.3% contributed just under 5.0% to the weighted average total inflation rate of 10.5%, with food prices up 16.8%, alcohol and tobacco up 3.7%, and energy prices up 52.8% contributing a further 1.8%, 0.2% and 3.5% respectively.

The right-hand side shows the 12 months to December 2023, where core inflation of 5.1%, food price inflation of 8.0%, alcohol and tobacco inflation of 12.9%, and a fall in energy prices of 17.3% contributed approximately 4.0%, 0.9%, 0.5% and -1.4% respectively to the weighted average total rate of consumer price inflation of 4.0%

The relative weightings may explain why many people feel that inflation is still running faster than the headline rate. Food prices, up 8.0% in the past 12 months, have increased twice as fast as CPI of 4.0%, while alcohol (up 9.6%) and tobacco (up 16.0%) have gone up by even more. These may have been offset by energy prices coming down by 17.3% over the past 12 months, but this may not be perceived as that beneficial given how energy is still significantly more expensive than it was before the cost-of-living crisis started.

For policymakers, the bigger concern will be the stickiness in core inflation, which remains stubbornly higher than the Bank of England’s target for overall CPI of 2.0%. While the expectation is that both core and headline rates will come down further during the course of 2024, the Bank is likely to remain cautious about declaring victory in the fight against inflation despite worries about the effects of high interest rates on the struggling economy.

This chart was originally published by ICAEW.

ICAEW chart of the week: Sterling exchange rates 2023

My chart for ICAEW this week looks at how the pound appreciated in value against the euro, US dollar, yuan and yen respectively during 2023.

4 x step charts titled 'Sterling exchange rates 2023'


Euro

30 Dec 2022: €1.128 = £1.00
Change: +2%
29 Dec 2023: €1.154 = £1.00


US dollar

30 Dec 2022: $1.204 = £1.00
Change: +6%
29 Dec 2023: $1.275 = £1.00


Chinese yuan

30 Dec 2022: ¥8.31 = £1.00
Change: +9%
29 Dec 2023: ¥9.08 = £1.00


Japanese yen

30 Dec 2022: ¥159 = £1.00
Change: +13%
29 Dec 2023: ¥180 = £1.00


4 Jan 2024.
Chart by Martin Wheatcroft FCA. Design by Sunday.

Source: Bank of England, 'Daily spot exchange rates against sterling'.

My first chart of the week of 2024 for ICAEW looks back at 2023 and how sterling strengthened against the euro, US dollar, yuan and yen – the currencies of the four largest economies in the world – based on exchange rates reported by the Bank of England.

The smallest increase was against the principal currency of the European Union, our largest trading partner, with the sterling to euro exchange rate up by just over 2% from £1:00:€1.128 to £1.00:€1.154 between 30 December 2022 and 29 December 2023. 

This contrasted with a 6% rise in sterling against the US dollar during 2023 from £1.00:$1.204 at the end of 2022 to £1.00:$1.275 at the end of 2023, a 9% rise against the Chinese yuan renminbi from £1.00:¥8.31 to £1.00: ¥9.08. Sterling increased, and a 13% increase against the Japanese yen from £1.00:¥159 to £1.00:¥180.

Exchange rate movements can be attributed to multiple factors, including relative rates of inflation and economic growth, interest rates, trade and investment flows, and fiscal credibility among others – both actuals and sentiment about prospects for the future. In sterling’s case, expectations that interest rates in the UK are likely to stay higher for longer than in other major economies is a key contributor to the rise in sterling over 2023, although this is only part of the story.

While sterling has appreciated over the last year against these and many other currencies, the pound is still much lower in value than 10 years ago, being down 4% against the euro compared with £1.00:€1.200 at the end of 2013, down 23% against the US dollar from £1.00:$1.653, and down 9% against the Chinese yuan from £1.00:¥10.01. The exception is the Japanese yen, where the rise this year has more than offset falls over the previous decade to leave sterling 4% higher against the yen than the exchange rate £1.00:¥173 on 31 December 2013.

Time to book that holiday to China or Japan?

ICAEW chart of the week: Silicon Valley Bank

My chart this week examines the late lamented Silicon Valley Bank and how its outsized investment in securities made it particularly vulnerable to a bank run.

Chart showing the consolidated balance sheet of SVB Financial Group (Silicon Valley Bank) at 31 Dec 2022.

Assets $212bn = Securities at amortised cost $91bn + securities at fair value $26bn + loans $74bn + cash $13bn + other $8bn.

Side column shows securities at fair value $102bn + underwater $15bn.

Liabilities $196bn = deposits $173bn + short-term debt $14bn + other $9bn.

Equity $16bn.

Silicon Valley Bank collapsed on 10 March 2023 after a bank run saw depositors rapidly withdraw funds as they lost confidence in the bank’s ability to survive. The bank’s collapse followed concerns that had been growing since 24 February 2023, when Silicon Valley Bank’s parent company, SVB Financial Group, published its annual consolidated financial statements for the year ended 31 December 2022.

As illustrated by this week’s chart, SVB’s consolidated balance sheet at 31 December 2022 comprised assets of $212bn, liabilities of $196bn and equity of $16bn. 

Assets consisted of investment securities recorded at amortised cost of $91bn, investment securities recorded at fair value of $26bn, loans of $74bn, cash of $13m, and other assets of $8bn. Liabilities comprised customer deposits of $173bn, short-term debt of $14bn, and other liabilities of $9bn (including long-term debt of $5bn). 

Not shown in the chart is the breakdown of equity of $16bn, which at 31 December 2022 primarily comprised preference stock of $4bn, additional paid-in capital of $5bn and $9bn of retained earnings, less $2bn in negative accumulated other comprehensive income.

As disclosed on the face of the balance sheet, the fair value of SVB’s $91bn portfolio of held-to-maturity investment securities was $15bn below its carrying value at amortised cost, reflecting how the main fixed-asset securities in this category – predominantly federally guaranteed mortgage-backed securities and collateralised-mortgage obligations – had fallen in value as interest rates climbed over the course of 2022. These unrealised losses of $15bn were not that far off the $16bn of equity reported by SVB, suggesting the bank would struggle if it ever had to sell these investments before they matured.

SVB’s intention had been to hold onto these investments, but circumstances changed on 9 March when depositors – concerned about further falls in the value of SVB’s assets as interest rates continued to rise during 2023, and an adverse reaction to a belated capital raising exercise launched by SVB on 8 March – withdrew $42bn in one day. This forced SVB to rapidly liquidate assets and borrow to find the cash required to repay depositors, but by then the first major digital bank run had gained too much momentum, with depositors attempting to withdraw a further $100bn on Friday 10 March. With insufficient cash to repay the amounts requested by SVB’s customers, the bank was closed by regulators that lunchtime.

A similar situation played out in the UK, where £3bn out of £10bn of deposits in SVB’s local subsidiary were withdrawn on Friday 10 March, causing the Bank of England to step in over the weekend to enforce a sale to HSBC for £1, a significant discount to previously reported equity of £1.4bn.

While banking regulators in the US, the UK and elsewhere will pour over the entrails of Silicon Valley Bank (and other recent bank failures such as Signature Bank of New York and Switzerland’s Credit Suisse) for some time to come, most commentators consider SVB to be unusual in how it had (or rather hadn’t) managed its exposure to changes in interest rates. At a minimum, closer regulatory supervision appears a likely consequence.

However, perhaps the biggest legacy of the failure of SVB is the decision of US regulators to protect the full amount of customer deposits and not just those covered by the $250,000 federal deposit insurance cap. For depositors in this mid-size banking institution that is of course good news, but the concern is that this might set a precedent for how to deal with potential bank failures in the future, where the price tag could be very much larger.

This chart was originally published by ICAEW.

ICAEW chart of the week: IMF Special Drawing Rights

My chart this week looks at the reserve currency assets that comprise the 660.7bn SDRs issued by the International Monetary Fund.

IMF Special Drawing Rights

Treemap chart showing the breakdown by currency of the 660.7bn SDRs in issue x $1.33 per SDR = $880bn.

USD: $383bn
EUR: €246bn = £261bn
CNY: ¥726bn = £105bn
JPY: ¥8,888bn = $66bn
GBP: £53bn = $66bn

Special Drawing Rights (SDRs) are reserve assets issued by the International Monetary Fund (IMF), the ‘international central bank’ for central banks. 

Just as national central banks create money by issuing currency in exchange for debt, the IMF creates its own form of ‘international money’ in the form of SDRs, balanced by long-term debt owed to the IMF by its member countries. 

To date, the IMF has issued 660.7bn SDRs, most recently in August 2021 when 456.5bn SDRs were issued to provide additional liquidity to member countries during the pandemic.

Countries are able to exchange the SDRs they are issued with for the underlying currencies that make up each SDR, providing them with international liquidity when they need dollars, euros, yuan renminbi, yen or pounds sterling or – in many cases – just dollars. According to the latest five-year currency weightings determined in July 2022, 1 SDR should be exchangeable for 0.57813 US dollars, 0.37379 euros, 1.0993 Chinese yuan, 13.452 Japanese yen and 0.08087 UK pounds. 

The chart illustrates what this means for the total of 660.7bn of SDRs in issue, which as of 5 Dec 2022 was calculated to be worth approximately $880bn in total based on a value of $1.33 per SDR. The total comprised $382bn in US dollars, €247bn in euros (worth $261bn at 5 Dec 2022), ¥726bn Chinese yuan ($105bn), ¥8,888bn Japanese yen ($66bn) and £53bn in UK pounds ($66bn).

In effect, 43.4% of the currency basket making up each SDR was US dollars, 29.7% was euros, 11.9% was Chinese yuan, 7.5% was Japanese yen and 7.5% was UK pounds.

Despite SDRs being an ‘international reserve asset’ that central banks and member countries can use to manage their own currencies, the IMF insists that SDRs are not a currency in their own right. Instead, it stresses that SDRs are merely an ‘accounting unit’ to be used for IMF transactions. However, despite these protestations, the IMF has concluded that SDRs are the functional currency for the purposes of its financial statements prepared in accordance with International Financial Reporting Standards.

The strength of the dollar means that SDRs at $1.33 each are worth $56bn less than the blended average rate of $1.42 each when they originally issued. This is because the non-dollar components of the currency basket, especially the euro and sterling, have fallen in value in relation to the US dollar in recent years.

At less than a trillion dollars, SDRs may seem quite small in comparison with the vast flows of money around the world. However, their importance to the international monetary system cannot be understated, keeping the financial wheels turning and providing central banks (especially those in smaller nations) with essential liquidity when they need it most.

This chart was originally published by ICAEW.

ICAEW chart of the week: Real interest rates

The ICAEW chart of the week looks at how real interest rates – net of inflation – remain stubbornly negative despite recent increases in the Bank of England base rate.

Chart with three lines - nominal yields on government debt, the Bank of England base rate and real yields on government debt. See text for details.

A feature of the economy since the financial crisis has been negative real interest rates, with the Bank of England reporting a -2.33% implied spot yield on 10-year government gilts as of 30 April 2022. This compares with a base rate of 0.75% on that day (since raised to 1%) and a nominal yield of +1.9%. With further increases in interest rates likely as the Bank of England seeks to bring inflation under control it is possible that real interest rates will become less negative over the next few months, at least assuming inflation peaks and doesn’t accelerate out of control.

Negative real interest rates are generally considered to be stimulative to the economy, reflecting the monetary policy support that the Bank of England has been providing since the financial crisis almost a decade and a half ago. Economic theory suggests that this should encourage spending and investment, as the nominal interest earned on savings will not be sufficient to offset the erosion in the value of money as prices rise over time.

The chart highlights how real interest rates were -2.59% in January 2020, before falling to almost -3.08% in June 2020 and bouncing around between -2.50% and -3.00% until November 2021 when they fell to -3.33%. They have since increased to -2.33% in April and to -2.20% as of 10 May 2022. Over that same period, nominal interest rates similarly based on government bond yields have fallen from 0.53% in January 2020 to 0.13% in July 2020 before increasing to between 0.3% and 0.4% until January 2021 after which they bounced between 0.8% and 1.0% until December 2021 since when rates have gradually increased to 1.92% on 30 April 2022, falling slightly to 1.86% on 10 May 2022. During this time, the Bank of England base rate was reduced from 0.75% in January 2020, to 0.25% and then 0.10% in March 2020 where it stayed until increasing to 0.25% in December 2021, to 0.50% in February 2022 to 0.75% in March 2022 and to 1.00% in May 2022.

The yields used in the chart are only one way of measuring real and nominal interest rates, and it is important to note that the former depend on the inflation expectations of market participants at particular points in time, which are not the same as the actual rates of inflation that are or will be experienced.

The challenge for the Bank of England over the next few months in tackling the current surge in inflation is how to take away the economic stimulus theoretically provided by negative real interest rates without causing a collapse in asset prices and a potential recession. A series of tough calls for even the most hardened policy makers.

This chart was originally published by ICAEW.

ICAEW chart of the week: UK International Reserves

We take a look at the UK’s official international reserves that are held to safeguard sterling and support monetary policy.

Step chart showing components of the UK International Reserves.

Gross reserves: £101bn foreign currency securities and deposits, £36bn IMF, £15bn gold, £23bn other instruments.

Liabilities: (£109bn) other instruments

Net reserves: £66bn

Our chart this week is on the UK International Reserves, which comprise foreign currency securities and deposits, gold, investments in the International Monetary Fund (IMF), and other financial instruments primarily used to manage sterling as a national currency and support monetary policy.

As illustrated by the chart, the combined total of UK government and Bank of England international gross reserves was £175bn at 31 March 2022, comprising £101bn in foreign currency securities and deposits, £36bn invested in the IMF, £15bn in gold and £23bn in other financial instruments. This was offset by £109bn in liabilities to arrive at net reserves of £66bn.

According to the Bank of England, the £101bn in foreign currency securities consisted of £75bn in bonds and notes issued by foreign governments, £15bn in foreign government money market investments, £6bn in foreign central bank deposits and £5bn in private sector securities. The £36bn invested the IMF comprises £6bn in IMF reserves (effectively the IMF’s share capital) and £31bn in Special Drawing Rights (SDRs), a government-specific financial asset underpinned by a basket of currencies (US dollar, Euro, Chinese Yuan, Japanese Yen and sterling). The UK government also owned or had rights to 9,976,041 fine troy ounces of gold worth £15bn on 31 March 2022, while other financial instruments of £23bn included £20bn of claims against counterparties on account of reverse repo transactions.

Reserve assets were offset by £109bn in liabilities, comprising loans and securities used to finance reserve assets, repo obligations, and derivative financial instruments including foreign currency forwards, cross currency interest rate swaps and sterling interest rate swaps.

Not shown in the chart is the split between the UK government’s net reserves of £66bn, consisting of £151bn in gross assets less £85bn in liabilities, and the Bank of England’s approximately zero net reserve position, consisting of £24bn in gross assets (£12bn in foreign currency securities and bonds plus £12bn in other financial instruments) less £24bn in liabilities.

The Bank of England manages both its own foreign currency reserves, used to support its monetary policy objectives of controlling inflation, and the UK government’s international reserves, most of which sit in the Exchange Equalisation Account established in 1932 to provide a fund that can be used, when necessary, to regulate the exchange value of sterling. In normal circumstances the Bank of England’s main objectives in managing the reserves are to ensure the liquidity of sterling, the liquidity and security of the reserve assets themselves, and to ensure the reserves are managed in a cost-effective way.

In normal circumstances, the reserves are not used to actively intervene in foreign exchange markets, but are kept ‘in reserve’ on a precautionary basis in case there is any change in exchange rate policy in the future or in the event of any unexpected shocks. More prosaically, they are used to provide foreign currency services for government departments and agencies needing to transact in foreign currencies, as well as to buy, hold and sell SDRs as required by the UK’s membership of the IMF.

Although relatively small in the context of over £1trn a year in UK public spending and £2.3trn in public sector net debt, the UK’s international reserves provide HM Treasury and the Bank of England with a substantial amount of firepower in the foreign exchange markets should there ever be a need to intervene to support sterling. Fortunately, almost all of the foreign currency securities and deposits held in the reserves are invested in governments and central banks of allied countries, a contrast to the position of Russia, which has seen a substantial proportion of its international reserves frozen following its invasion of Ukraine.

One piece of good news amid all the economic gloom at the moment is that the UK International Reserves aren’t hitting the headlines. Because when they do, you really will know that all is not well.

This chart was originally published by ICAEW.

ICAEW chart of the week: Consumer Prices Index

My chart this week looks at how price rises have accelerated over the last few months, with consumer price inflation reaching 4.2% in October, the highest it has been for a decade.

Line chart showing how the Consumer Prices Index has increased from 106.7 in Oct 2018 to 107/6 in Apr 2019 to 108.3 in Oct 2019 (a +1.5% increase over a year earlier) to 108.5 in Apr 2020 to 109.1 in Oct 2020 (up 0.7% over the year) to 110.1 in Apr 2021 to 113.6 in Oct 2021 (a 4.2% annual increase).

The Office for National Statistics published its latest estimates for inflation on Wednesday 17 November, reporting a 12-month increase in the Consumer Prices Index (CPI) of 4.2% and a 12-month increase in the Consumer Prices Index including owner occupiers’ house costs (CPIH) of 3.8%, both of which are the highest they have been since November 2011 when CPI was 4.8% and CPIH was 4.1%.

CPI and CPIH are calculated using a basket of goods and services to assess the level of inflation experienced by consumers, with the current index set to 100 in July 2015.

The ICAEW chart of the week shows how CPI fell before increasing from 106.7 in October 2018 to 107.6 in April 2019 and 108.3 in October 2019, an annual increase of 1.5% that was within the 1% to 3% Bank of England target range. This was followed by smaller increases to 108.3 in April 2020 and 109.1 in October 2020, a 0.7% annual increase in CPI driven in part by the pandemic. The index hovered around that level for several months until starting to increase more rapidly from March onwards as the economy started to re-open, reaching 110.1 in April 2021 and continuing to increase sharply to 113.6 in October 2021, an annual increase of 4.2%.

The Governor of the Bank of England is required to write to the Chancellor of the Bank of England whenever inflation is more than 1% above or below the 2% target and he did so on 23 September when inflation reached 3.2% and he will again now that it has reached 4.2%. Part of the explanation he has given and will give are ‘base effects’, where price discounting during 2020 at the height of the first and second waves of the pandemic suppressed some of the inflation that is being experienced now.

Further letters are likely over the next few months as even if prices don’t rise any further, given how the index bounced around the 109 level between September and March 2021. This means inflation should continue to stay substantially above 3% for the next four months or so unless prices were to fall again, which is unlikely given how global commodities and supply constraints continue to feed into rising domestic prices. A 12-month CPI-inflation rate of 5% appears more than likely at some point in the next few months.

The Bank of England’s Monetary Policy Committee (MPC) isn’t panicking at this stage given that the annualised rate of inflation over the last three years (comparing October 2021 with October 2018) is an almost on-target 2.1% and their expectation that inflation rate will come down once the flat inflationary period of a year ago starts to drop out of the comparison. However, they are sufficiently concerned about the steep slope in the CPI in the last few months to signal that interest rates may need to rise if prices continue to increase at the pace seen in recent months.

The MPC’s original plan was to hang tight through what they hoped would be a short inflationary spurt as the economy emerges from the pandemic. In the event it looks like they won’t be able to hold that line, with higher interest rates a distinct possibility in the coming months.

This chart was originally published by ICAEW.

ICAEW chart of the week: Banknotes in circulation

Our chart illustrates how banknotes in circulation have grown during lockdown despite a decline in cash usage. Will the new £50 note launched on Wednesday cause a further rise?

Chart showing steady growth in banknotes in circulation from £26bn in 2001 to £69bn in 2017, followed by three flat years including £70bn in 2019, before a jump to £80bn in 2021. The latter comprised £18bn in £50 notes, £45bn in £20 notes, £15bn in £10 notes and £2bn in £5 notes.

At 28 February 2021, there were 357m paper £50 notes worth £18bn, 2,237m polymer and paper £20 notes worth £45bn, 1,540m polymer £10 notes worth £15bn and 407m polymer £5 notes worth £2bn – a total of £80bn in circulation. This excludes around £8bn in Scottish and Northern Irish banknotes and in the order of £5bn in coins.

With around 60m people in England and Wales (as Scotland and Northern Ireland have their own banknotes), this is equivalent to approximately six £50 notes, 37 £20 notes, 26 £10 notes and seven £5 notes per person. Of course, not all of these are in purses, wallets or stuck down the back of sofas – many live in cash drawers and safes at high street banks, retailers and other businesses, as well as a certain proportion that have migrated around the world.

There has been some speculation about the reasons for the jump in cash holdings during the pandemic, which appears counterintuitive given the significant decline in cash usage as contactless and online payments have become more popular. Part of this may be hoarding in the context of a national emergency, while others have speculated that criminal enterprises have struggled to launder cash at a time when many retail businesses have been closed. Another potential driver is the crossover between the old and new £20 notes, with the polymer £20 launched in February 2020 while the paper note it replaced is still in circulation. With the announcement that both £20 and £50 paper notes will be withdrawn in September 2022, there is likely to be a flood of cash coming back to the Bank of England next year.

The new Turing £50 note completes the changeover from paper to polymer, joining the Churchill £5, the Austen £10 and the Turner £20 polymer notes. The Adam Smith £20 note and the Boulton-Watt £50 note are the last paper notes still in circulation.

Speaking at Bletchley Park, where Turing carried out his famous codebreaking work, Bank of England Governor Andrew Bailey said: “Our banknotes celebrate some of our country’s most important historical figures. That’s why I am delighted that Alan Turing features on the new polymer £50 note. Having undertaken remarkable codebreaking work here at Bletchley Park during the Second World War, he went on to pioneer work on early computers, as well as making some ground-breaking discoveries in the field of developmental biology. He was also gay and was treated appallingly as a result. Placing him on this new banknote is a recognition of his contributions to our society, and a celebration of his remarkable life.”

More information on banknotes is available from the Bank of England.

This article was originally published by ICAEW.

Plastic is the future for cash – one way or another

22 September 2020: Physical cash use is declining fast, leaving the fixed cost base for processing cash transactions at risk of stranding. As cards and digital forms of payment become more prevalent, what will happen to those who still need access to cash?

The National Audit Office (NAO) issued a report on 18 September 2020 on the production and distribution of cash. It looks at what the Bank of England, the Royal Mint, HM Treasury and financial regulators are doing in response to a 59% decline in the volume of cash transactions between 2008 and 2019, as well as efforts to improve the efficiency of cash production and reduce counterfeiting.

According to data from UK Finance, cash payment values fell from £267bn in 2008 to £141bn in 2019 and were (prior to the pandemic) forecast to fall to £59bn by 2028.

Coin production has fallen significantly, with 383m coins manufactured for circulation in 2019-20 compared with 1.1bn in 2010-11. Notes in circulation have continued to increase (to 4.4bn notes with a monetary value of £76.5bn in July 2020), but only around 20%-24% of these are used for cash transactions and 5% used for savings, leaving over £50bn whose location is uncertain – a point which the NAO believes deserves further investigation.

A key finding from the report is that there is no single body in government responsible for overseeing how well the cash system is performing, despite the establishment of a Joint Authorities Cash Strategy Group (JCAS) focused on access to cash for those that need it, in particular for the million or so UK adults who do not have a bank or building society account.

The UK’s entire cash infrastructure across the public and private sectors is estimated to cost around £5bn a year, with many of these being fixed costs that with declining usage are putting pressure on the cash system. 

The number of ATMs fell by 12% over the two years to December 2019 to around 60,000, with a fall of 17% in the number that were free-to-use to around 45,000. The Payment Systems Regulator (PSR) has been working with the industry to maintain free-to-use ATMs in geographic areas where provision is most limited, although the NAO recommends greater attention is given to more deprived areas.

Demand for notes and coins declined by 71% between early-March and mid-April 2020 during the COVID-19 lockdown but has since recovered. The NAO believes it is still too early to assess the longer-term impact on cash access and usage but moves amongst some retailers to suspend acceptance of cash during the pandemic could further accelerate the switch to non-cash forms of payment.

The NAO is positive about the steps the Royal Mint and the Bank of England have taken against counterfeiting. In 2016, about one in 30 £1 coins was a counterfeit, but surveys since 2018 have found very low counterfeiting rates for the new £1 coin. The introduction of the polymer £20 note, traditionally the denomination favoured by counterfeiters, should also help reduce the cost of fraud to consumers and businesses.

The Royal Mint reported a reduced loss of £3.9m on its coin-making activities in 2019-20, with actions to improve efficiency including a 22% headcount reduction within its currency division and the mothballing of two of its six plating lines. The Bank of England has also worked with De La Rue to improve efficiency, albeit each polymer banknote costs 60% to 80% more than a paper one, even if they are expected to last at least 2.5 times longer. 

The NAO recommends that HM Treasury takes another look at the roles and responsibilities of the bodies involved in the cash system, setting out more clearly the specific outcomes it wants to deliver for consumers and small businesses and how this should be balanced against the cost of doing so. It also believes that a plan is needed to take action if some groups become left behind as the cash system changes.

Martin Wheatcroft FCA, adviser to ICAEW on public finances, commented: “The NAO has provided some extremely useful insights into how the UK’s cash system is coping with declining usage and it makes a number of sensible recommendations for improvements. 

“However,” continued Wheatcroft, “the report does not answer the more fundamental issue of whether cash has a long-term future at all, and in particular whether the multi-billion costs of running cash and other legacy payment systems could be better deployed.

“Ultimately, is it now time to look beyond a managed decline of the cash system and explore more radical options?”

Front cover: NAO report 'The production and distribution of cash'. Click on the image to go to the NAO website.

This article was originally published on the ICAEW website.