Why interest rates won’t be going up
IF you owe a lot of money to your bank, it’s time to rejoice. There is now almost no chance of interest rates going up this year. The Bank of England’s monetary policy committee voted 7-2 to keep rates on hold; and given the arguments and worries about growth expressed by the majority of the members it would be foolish to bet on a rate rise any time soon. Even another bout of quantitative easing is no longer out of the question any more. Savers will continue to be hammered; those with large mortgages will continue to see the value of their debt eroded as the pound’s purchasing power keeps dropping.
It is fair to assume that prices will rise by 5-6 per cent this year: for someone with a £200,000 mortgage, that is equivalent to a gift of £10,000-£12,000. Someone with a £400,000 mortgage will see the value of their debt fall by £20-£24,000 in real terms. If on top of all of that the homeowner happens to have a tracker mortgage handed out during the bubble days with a very low rate of interest, the windfall will be massive. People with big mortgages and low interest rates are gaining immensely, at least if they are prepared to weather the downturn in house prices; people facing ever-higher rents are being hammered.
Savers are even bigger losers and are directly paying for the gains being made by those with large debts. Interest rates on savings products are miserably small and capital is being depleted. As ever, inflation is transferring wealth from those with savings to those with debt. The poor and those on fixed incomes are being hit the hardest and retail sales are under intense pressure.
So how come the Bank is tolerating so much inflation? One reason is that the money supply is growing very slowly. But as Simon Ward of Henderson points out, the Bank is underestimating the increase in the rate at which money is circulating around the economy (its “velocity”). Such a shift always happens when real interest rates become negative.
There is another, more important reason. The Bank’s monetary policy objective is to deliver “price stability” – or more accurately, lowish consumer price inflation – and, subject to that, to support the government’s economic objectives including those for growth and employment (these include “to achieve strong, sustainable and balanced growth that is more evenly shared across the country and between industries”). The inflation target is two per cent on the CPI measure; the Bank is allowed to overshoot or undershoot by one per cent. The Bank, unlike the Fed, is meant to focus exclusively on inflation. But the pureness of its mission is limited by a key sentence: “The MPC’s aim is to set interest rates so that inflation can be brought back to target within a reasonable time period without creating undue instability in the economy.” The reason why large hikes in rates are not now being introduced is that this, the Bank claims, would create too much instability or volatility in output, as Sir Mervyn King called it. The trouble with invoking this get-out clause is that virtually all deviations from the inflation target can be ignored. This is especially risky given that the UK is now in a very different place intellectually to other countries: we are the only major economy to be so relaxed about rocketing inflation. Sometimes, splendid isolation can be a good thing – but when it comes to inflation, it is very dangerous indeed.
allister.heath@cityam.com
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