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After much speculation, last month the Bank of England has finally raised interest rates from 0.25% to 0.5%. For many economists this was a risky move, coming as the UK economy is weakening in the face of falling consumption and higher inflation. In contrast, we wonder if it is too little, too late - should rates have been increased some time ago?
In real terms, the impact of a rate rise is likely to be limited. Certainly, it hits those on variable rate mortgages and the Bank of England estimates put this at around 40% of homeowners, but groups such as the Yorkshire Building Society have reported a surge in homeowners fixing their rates in the weeks ahead of the rate rise. Equally, there is evidence that those with the largest loans – who would otherwise be the most vulnerable – tend to secure fixed deals.
To date, fixed rate mortgages have been largely unchanged by the interest rate rise. Research from Royal London has shown that many fixed rates are the same or lower than they were prior to the interest rate rise. Gilt yields – which determine the pricing for fixed rate mortgages – have actually fallen slightly since the rate rise, following Mark Carney’s dovish comments on future rate rises.
Mortgage debt is, of course, only one form of debt. One of Carney’s key motivations in raising rates was to curb the supply in consumer debt. In September, the Bank of England issued a warning about the UK’s ballooning consumer debt, such as credit cards, personal loans and car finance, saying Britain’s banks could incur £30bn of losses if interest rates and unemployment rose sharply. That said, given the 20%+ interest rate on overdrafts and credit cards, 0.25% is unlikely to shift the dial significantly.
As expected, banks have been slow to pass on the rate to savers. As such, an interest rate rise has done little to boost the beleaguered retiree looking for an income from his or her savings. Savings account rates remain at rock bottom.
With this in mind, it seems interest rate rises may not make a significant difference to the economy, just taking a small edge off the UK’s already declining growth. In this case, does it matter whether interest rates are higher or lower?
For us, it is about ensuring that monetary policy is appropriate to the prevailing environment. Complicated by Brexit, the current climate is undoubtedly difficult, but is it more unusual than two World Wars? Than the Cold War? Than the deflation of the 1970s? Since the start of the 20th century, the average long-term interest rate has been 5.6%. Even excluding the period of high inflation from the 1970s to the 1990s, it is 4.3%. There may be much hang-wringing about GDP growth, but it is still running at 0.4% quarter on quarter (Q3) and has been higher. To our mind, interest rates have long looked inappropriate for the level of growth in the economy.
What are the likely consequences of too loose monetary policy? In theory, the problem is that it encourages chaotic lending and promotes inflation. This was already happening, with levels of unsecured lending (credit cards and personal loans) rising in the UK. Time will tell whether the interest rate rise has come soon enough to prevent it impacting inflation. With wage growth still trailing inflation, there are few signs of soar-away inflation, but markets remain woefully unprepared for any resurgence.
There is a broader question on whether low interest rates have prolonged market agony and stifled growth. This is more difficult to judge, but there is some logic to it. Low borrowing costs have let ‘zombie’ companies survive and allowed people to neglect their household debt burden.
Perhaps more importantly, it has suggested a crisis at a time when the economy was growing at a reasonable pace. Had the Bank of England raised rates some time ago, they would have been doing so from a position of strength, at a time when the UK economy was buoyant. Today, it is difficult to make the same argument.
If the interest rate rise is not enough to put the inflation genie back in the bottle and it starts to rise, policymakers have to move quickly but a rapid rise in interest rates has often been the trigger for recession.