The CBI has predicted that interest rates will rise to 2.75 per cent by the final quarter of 2012. The Telegraph has put the CBI projection together with figures from the Council of Mortgage Lenders (CML) and worked out that around three million householders will run into difficulty paying their mortgages if the CBI is right. Well, if the Telegraph is right, then that really would be a major concern. House price falls would turn into an outright crash, creating even more problems for the mortgage market, leading to property repossessions, creating more house price falls, and in turn leading to another banking crisis. If the CBI is right, and the Telegraph projection is right, then the consequence will quite simply be an economic disaster. Fortunately, we suspect the CBI is wrong, and wrong for one very simple reason.
The CBI is actually quite bullish. It reckons Q1 of next year will be tricky, with the hike in VAT pushing down on consumer spending, and that the UK economy will expand by a mere 0.2 per cent. For Q2 it is forecasting 0.4 per cent growth, followed by 0.5 per cent in both Q3 and Q4. But, and here we have room for cheer, the CBI says that it “still considers the risk of a double dip back into recession to be low.” See: Growth will still be slow in third year of recovery – CBI
Alas, it reckons inflation will stay over the Bank of England’s target next year and says that the Bank of England “will start to normalise monetary policy in the spring, with interest rates rising gently through to mid-2012, followed by a slightly faster monetary stimulus withdrawal over the second half of 2012.” It says that: “This will take the Bank Rate up to 2.75 per cent by Q4 2012.”
Meanwhile, the Telegraph has taken a good look at figures released by the CML a few weeks ago, and concluded that under the new criteria defined by the FSA for responsible mortgage lending, then if rates did indeed rise to 2.75 per cent, no less than three million households would have mortgages that our financial regulator considers to be un affordable. See: 3m home owners could ‘struggle to pay mortgage’
It is worth bearing in mind that the FSA has won no friends with its latest ideas for dealing with the problems of the mortgage market. It wants to make mortgage lending more responsible, wants to see higher deposits, and wants to see much lower ratios of mortgages to income. But the Council of Mortgage Lenders has looked at the FSA’s ideas and concluded that no less than 51 per cent of all loans completed between Q2 2005 and Q1 2009 would not have been offered if these FSA proposals had been in force then. In fact, it says that of the eight million mortgages granted during this period, around half would not have been granted, and yet says in practice, just 200,000 loans defaulted.
So what it boils down to is this. If rates did indeed rise to 2.75 per cent, then there will be three million mortgages out there that would not have been approved under planned FSA guidelines.
So this is not really the same thing as saying these mortgages are not affordable, merely that the FSA is worried about them, and let’s face it, the FSA seems to worry about everything bar the things that really matter – such as a banking crisis in the making.
And yet the Telegraph has a good point. We have warned in this column over and over again on how wages growth is set to lag way behind inflation as measured by the retail price index (RPI) next year. One of the aspects of the RPI index that makes it a good guide to real inflation, is that it includes rent and mortgage payments. So, if interest rates go up, so will the RPI. If the CBI is right, wages will continue to lag way behind inflation for at least two years.
We find it inconceivable that in such circumstances house prices won‘t fall and repossession rates won’t rise, and consumers won’t cut spending.
And yet, falling house prices, rising repossessions and declining consumption are the conditions that lead to deflation.
To our way of thinking, then, there will be no need to up rates to 2.75 per cent, because if the Bank of England were to do this, inflation would significantly undershoot its target, and then stay below target for years.
In other words, rates won’t rise to 2.75 per cent, precisely because such a move would be so disastrous.
Of more concern is the danger that interest rates may rise over the next few years because of factors beyond the Bank of England’s control.
Last week, McKinsey Global released one of the most interesting reports we have seen in a very long time. It predicted that over the next few years demand for investment will rise, just as global savings fall. As a result, it says real interest rates across the world will rise.
The report was actually presenting good news, because it was suggesting reasons why the global economy may be about to embark on another golden age of growth. But, higher interest rates will be a symptom of this new era it has forecast. And high rates will be bad indeed for debtors, and that, alas, includes UK households which bought property on cheap rates, without factoring in that over a 25-year period there was a danger rates would rise significantly, and house prices could fall. See: Interest rates set to rise as economic tectonic plates shift – is this good or bad news?
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