Who is the real rate-rise winner?

All bets are off as the Bank of England's Monetary Policy Committee meets this week to decide on interest rates, prompting one City analyst to say: 'Unless we are all terribly wrong, the base rate is going up from 4.5% to 4.75%.'

If the expected announcement comes on Thursday, attention will focus on the cost to borrowers of the fourth rate rise this year.

And quite right, too. As the independent Item forecasting group noted on July 19, the consumer is acutely vulnerable to increased borrowing costs.

Item said that if rates were to touch 5.5%, mortgage interest payments will take 6% of household disposable income - up from 4% last year. Add in other debt interest and the rise goes from 7.2% to 10%.

But what of the winners from higher lending costs? No, not those with savings. The real winners ought to be none other than the banks.

Not that you will hear them talk about it much, or, indeed, at all. Neither is it greatly discussed by City economists who, in many cases, are their employees. Members of the public who give it any thought probably imagine that base rate rises are fairly neutral for the banks, with any gains made from higher charges to borrowers being cancelled out by higher payments to depositors.

This misconception suits the banks. But it is just that - a misconception. With an important qualification, of which more later, rising base rates are good news for banks for two reasons.

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First, and most obvious, is the time-lag between the almost immediate upward adjustment of their rates for borrowers and the generally much tardier upward adjustment of their rates for savers.

The second reason is less obvious and far more lucrative. Low base rates narrow the 'spread' between the rates paid to depositors and charged to borrowers.

In a very simple example, a base rate of 2% might mean £100-worth of deposits would cost a bank 1% and be loaned out at 3%, a spread of 2%.

If all those rates were to double overnight, the depositor would receive two%, but the borrower would pay 6%, giving the bank a spread of 4%. Its 'cut' would rise from £2 to £4 on an identical transaction.

This basic example assumes banks merely lend out money deposited with them. In fact, they are licensed to create money out of thin air. Under international rules, banks can lend out £100 for every £8 taken in deposits. Why? Because only a small proportion of deposits is withdrawn on any one day, and because the loans themselves become deposits and form the basis for yet more loans.

Until 1971, this licence to print money was strictly curbed by the authorities. Since then, controls have been progressively lifted and banks are free to lend pretty much as they wish.

Of course, the whole reason the MPC raises interest rates is in response to excessive credit creation in the economy. And when it does, those responsible for this excessive credit creation - the banks - then make an extra profit. Nice work if you can get it.

Ironically, the only time that any of this undeserved second profit was confiscated was by a Tory Chancellor. In 1981, Sir Geoffrey (now Lord) Howe levied a £400 million 'windfall tax' (equivalent to about £960 million today) on the banks.

But before a cash-hungry Gordon Brown thinks of something similar, two points should be made.

First, Howe's interest-rate thrust was far more aggressive than anything we are likely to see, peaking at 17% in 1979/1980.

Second, in 1981 banks had just ten% of the mortgage market. Today, the banks have more than 77%, exposing them more directly to the risk of a house-price crash.

This may explain why, despite a 20% boost in rates this year, from 3.75% to 4.5%, bank shares have underperformed the FTSE 100 Index by 3.4%.

Could the banks' plunge into mortgage lending pull the plug on their magic money machine? Maybe. But don't bank on it.