Northern Rock, the state-owned lender, has embarrassed the Government by increasing rates on its most competitive deals despite calls for high street lenders to pass on cuts in borrowing costs.

This morning, the bank, which was nationalised in February, increased interest rates on its fixed-rate deals by up to 0.3 percentage points, adding up to £40 a month to the cost of monthly interest-only repayments on a £150,000 loan.

Its most competitive one-year fixed mortgage has jumped from 3.99 per cent to 4.19 per cent.

In a further blow to homeowners, HSBC has also increased the interest rate on its most competitive tracker yesterday. It's lifetime tracker, which is pegged to the base rate, has increased from 0.99 above base, or 3.99 per cent, to 1.64 per cent above base.

In the last week, the Government and the Bank of England have warned banks it is vital for the economy that they boost lending and reduce interest rates in line with the falling base rate.

Yesterday, Mervyn King, Governor of the Bank of England, told the Treasury Select Committee: “I am in no doubt that the single most pressing challenge to domestic economic policy is to get the banking system lending in any normal sense. That is more important than anything else at present.”

Lord Mandelson, the Business Secretary, has said he will force banks to lend or face legal action as part of a new code of practice on lending.

Melanie Bien, director of Savills Private Finance, a broker, said: "Borrowers will be bemused that the state-owned lender is raising its fixed rates when the government is pushing lenders to pass on rate reductions.

"Northern Rock's original reductions were too aggressive, making it difficult to cope with demand. It is evidence of the fact that the majority of lenders are not offering competitive fixes."

Earlier this month, the Bank of England dramatically reduced its interest rate by 1.5 per cent in an effort to kick-start cheaper lending.

It is now reportedly considering another large reduction next month after widespread disappointment that mortgage rates have not fallen as much as expected.

Northern Rock was one of only a handful of lenders to launch cheaper fixed rate deals after a considerable fall in swap rates, the wholesale money markets which lenders use to fund new fixed-rate lending.

This week, the two-year swap rate, which determines the cost of two-year fixed-rate deals, fell to its lowest level in more than 5 years. Yesterday two-year swaps were at 3.23 per cent.

Aaron Strutt, of Chase de Vere Mortgage Management, said: "It will certainly be worrying for homeowners that a nationalised bank is raising rates at a time when wholesale funding is getting cheaper."

Lenders have more than tripled the profit margins on fixed-rate lending in the last year. The gap between the cost of funding new fixed-rate lending on the money markets and the rates that banks charge hard-pressed customers has jumped from 0.8 percentage points last year to 2.6 percentage points today, according to Moneyfacts.co.uk, the financial website.

The market for fixes also remains limited. Moneyfacts says there are 894 fixed-rate deals available today, compared to 1,774 deals at this time last year.

Michelle Slade, of Moneyfacts.co.uk, said: "The margin between the average fixed rate and swap rates continues to increase. Borrowers should be able to benefit from fixing their rates at much lower levels by now, but the cuts aren't filtering through."

Woolwich, the mortgage arm of Barclays, is still offering a mortgage deal with a rate of 3.99 per cent fixed for a year. However, homeowners are tied in for a total of three years at a less competitive tracker rate. Halifax, the UK's biggest lender, Abbey, Chelthenham & Gloucester, the lending arm of Lloyds TSB and Alliance & Leicester have all launched new fixed-rate deals in the last month which have been substantially higher than the base rate.

The Government has pumped £37 billion into Britain's banking industry but lending has continued to collapse. Last month the number of new loans fell by 52 per cent compared to the same month last year, according to the British Bankers' Association.

Lending from Britain's main high street banks fell to £2.9 billion, from £3.5 billion in September, and £1 billion below the previous six month average figure of £3.9 billion.

Northern Rock and HSBC have defended the increases in rates, arguing that they have been forced to make changes in order to manage demand.

Since being nationalised, Northern Rock has had to strike a balance between shrinking its mortgage book whilst remaining open to new mortgage lending. It has so far repaid £9.4 billion of government loans taken out when it was nationalised, reducing its outstanding debt to £17.5 billion.

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