As I write this piece, the Bank of England (BoE) has just increased the base interest rate to 5%. This is a 0.5% rise and adds yet more to the pain of inflation of those paying off a mortgage on their house. The reason behind this rate increase is ‘sticky inflation’.
No, the bank is not worrying about the price of jam (it is, but only so far as the price of jam affects food price inflation), but because the bank and economists thought that, once the energy price spike had worked through from the invasion of Ukraine by Russia, and food price inflation arising from the same event had also worked through, inflation rates would come tumbling down. Price inflation has not been obedient to the wishes of the Bank.
Mind the gap!
Far from plummeting as it should do, inflation is stuck or even rising slightly. Why is this? The BoE points to a combination of factors, what they call ‘excessive pay rises’ and ‘excessive price rises’. Quite what excessive means is not clear.
In May, a pay rise surprise where pay rises were recorded as reaching 7.2%, started the ball rolling for the BoE to react as it has done. The governor of the bank, Andrew Bailey, was not very self aware when he started to lecture hard-pressed consumers that they were asking for too much pay and should tighten their belts. Bailey’s pay is set at £600,000, including benefits etc, so perhaps a little fiscal restriction at the bank might be applicable. Pay in many sectors has been suppressed for so long that sooner or later something would give.
“Regular (nominal)” means the numerals on your regular pay packet. “Total” counts this plus any bonuses. “Real” means what that money will actually buy. You can see from the graph that the gap between the nominal and the real is the largest it has been since 2001.
There is a suspicion that companies may be taking the opportunity to increase profits by increasing prices, but this is disputed. The food industry is being accused of profiteering, but the data is not convincing, especially where UK supermarkets are concerned.
What seems to be happening is that workers are receiving pay increases but mostly well under the rate of inflation, profit margins in the corporate world might not have fallen, and lower commodity prices have not yet fed through because the food industry buys ahead to secure supplies.
Inflation ‘Whack-a-mole’
The BoE seems determined to play ‘Whack-a -mole’ with inflation shock, using interest rates as a mallet to the point where the Bank of England “has to create a recession” partly to “nip in the bud” a spiral of wages going up and in turn pushing up prices, and then pushing up wages again. Karen Ward, who serves on the chancellor’s board of advisors, is advocating this course of action. My advice to Ward would be to be careful what you wish for, because it may be granted in ways you might not appreciate. If the bank starts a recession it may become unstoppable. If this were to happen asset values including house prices could tumble, and unemployment could increase substantially, creating social and political instability.
The UK economy and society have been reasonably resilient since the millennium, in spite of the credit crunch, Brexit, Covid and, more recently, ‘Trussonomics’, but there are limits to endurance, that even a society which accepts these events with fortitude, will not endure quietly.
I am not at all sure if the recently rehabilitated cult of the expert could survive yet another economic shock. Trust in government was never high and is at a low point, though trust in certain public organisations such as the NHS, still remains high, in spite of some egregious failings. Public trust in business is not overwhelming. The public standing of the CBI, Southern Water, South Eastern Water, Trans-Pennine Express, Serco, Capita, G4S, any bank, etc etc, is not high, yet some business leaders still behave as if the social norms of society do not apply to them.
Economic commentators have discussed higher mortgage rates and their effect on homeowners, and also on landlords and tenants. It is true that those seeking a mortgage or remortgaging are in for an unpleasant shock, but the ripple effect of high interests will affect other areas of credit. First, let us get rid of this notion that mortgage holders are being snowflakes because interest rates have increased to 5%, whereas on Black Wednesday interest rates went up to 15%. This ignores the effect that historically low interest rates over a long period, has had on asset values, houses in particular.
Personal experience
In 1991, I had a mortgage of £15,000 on a house worth £80,000. Today that house may be valued at around £450,000 to £500,000, requiring a £100/200,000 mortgage or more to finance its purchase. Even if I was earning double or triple what I was earning then, that is still a hefty chunk of taxed income, so I think the older generation ought to refrain from suggesting that the young should dispense with Netflix, and live the simple life.
PCP
There are a lot of sectors which have not been mentioned. Have you noticed the number of SUVs and luxury cars there are on the roads? How can so many people on modest incomes afford these vehicles? The answer is PCP finance or personal contract purchase. These deals set a notional residual value for a vehicle and one pays off part of the value, leaving a remaining ‘balloon payment’ to acquire the rest of the car. In essence, you are renting the vehicle for three to five years and then, if the mileage is within bounds and the condition within contract, you can buy the remainder or walk away. Most walk away, to buy yet another car on a similar deal.
The car companies like them because there is no haggling over price. The dealers like them because of the commission on sales, so everyone is happy. Well maybe not. It all relies on reasonable levels of disposable income and relatively low interest rates. If PCP deals start going sour, because the owners are in a tight financial spot, what happens then?
Equity release
Another sector that is often not considered, is ‘Equity release’. In some formats these are lifetime mortgages at higher rates than a normal mortgage (2–3% more). These have caused misery in the past, when borrowers found that the equity in their home was insufficient to pay off the loan. There is supposed to be a guarantee of no loans to exceed the value of the remaining equity, but has this guarantee been pressure tested? Could we see harrowing cases of old people turned out of their houses, because they took out a small loan ten or 15 years ago. What happens if the interest on the loan has ballooned because of compound interest and the value of their house has either fallen or not risen to cover the interest debt?
Equity release is heavily promoted in all forms of media, and what may seem a means for a more comfortable retirement could become a nightmare, under certain conditions such as higher than anticipated interest rates. Watch this space.
Debt time bomb
UK government debt rises above 100% of GDP for first time since 1961, is a recent headline. GDP or gross domestic product is a measure of the size and health of a country’s economy over a period of time (usually one quarter or one year).The national debt has now exceeded GDP. This is not unusual, for much of the 20th century this was the norm, because of war, the great depression etc.
Many countries routinely breach this limit, and as long as their creditors are prepared to finance the debt, all is fine, but there are limits, as Liz Truss and Kwasi Kwarteng found out.
We could ask why the UK endured a sustained period of severe austerity, leaving public services unable to cope with the pandemic. With hindsight, would a more graduated, targeted, austerity policy, have been more prudent. We had an ongoing ‘debt time bomb’, which is not helped by silly politicians saying daft things about cheese sandwiches in throwaway statements that are reminiscent of ‘let them eat cake’.
Household debt has not been adequately addressed, leading to a crisis, especially for those on low incomes, and it is now going to be made worse by spiralling interest rate increases from lenders. Citizens advice and other debt charities have been reporting an increased number of clients, and food banks have received a surge in requests for help.
In short, a rise in interest rates is bad news for those who carry debts, whether these are for a house mortgage, a car or consumer credit. For those already struggling, a rise in their rent, and rising prices of food, may mean they need to seek such help urgently.
