Yves here. Admittedly, the US isn’t facing anything close to the severity of the UK’s energy and food crises. And accordingly, our official inflation isn’t as acute either. But expect the Fed to follow the Bank of England in “The beatings will continue until morale improves” interest rate increases which will do little to curb inflation
By Richard Murphy, a chartered accountant and a political economist. He has been described by the Guardian newspaper as an “anti-poverty campaigner and tax expert”. He is Professor of Practice in International Political Economy at City University, London and Director of Tax Research UK. He is a non-executive director of Cambridge Econometrics. He is a member of the Progressive Economy Forum. Originally published at Tax Research UK
I posted this thread to Twitter this afternoon:
The FT noted this morning that “Financial markets are betting the Bank of England will more than double interest rates by May next year.” That means rates of 4% are being pencilled in. This is another catastrophe in the making…a thread
Bank of England base rates matter. They establish the basis for all other interest rates in the UK – with mortgage rates being part of this – but many other loans also have their rates changed when this one does.
So what would the impact of an increase in Bank of England base rate to 4% be on top of all the other crises that we face? I am just going to look at the resulting mortgage issues for now.
The Office for National Statistics say that there are 6.8 million owner-occupied households in the UK with a mortgage; rather surprisingly a smaller number than the 8.8 million homes owned outright.
Total mortgages outstanding were about £1,630 billion in March 2022 according to the Bank of England. That is £239,700 per household with a mortgage, near enough.
Most people on fixed rate mortgage deals were paying between 1.5% and 1.7% before current rate rises. Interest rate rises of 1.65% have changed this. It’s very hard to find a decent mortgage deal for less than 3.5% now, and many are higher.
In other words, rate rises are flowing straight through the system, with a margin for error being added in lenders’ favour.
Assuming a person who has been on fixed rate comes off their deal next spring and by then Bank of England rates have risen to 4%, meaning mortgage rates are likely to be around 5.5%, and maybe more, what will that mean for their mortgage costs?
Currently, assuming interest only payments on £239,700 at 1.7% (and I am rounding here) the cost will be around £4,080 a year, or £340 a month.
If the deal was a rather more sensible repayment mortgage the cost would increase to £14,150 a year at 1.7% over 20 years, or £1,180 a month.
Now move to 5.5% and the repayment only mortgage now costs £1,100 a month – an increase of £760 a month, or £9,120 a year.
Looking at the repayment option (which wise people might have) the cost would be £1,650 a month or £19,800 a year, an increase of £470 a month.
On top of energy, food and other price increases these costs are simply not affordable. For very large numbers of households this will be the moment when they admit that paying for the house they always thought to be theirs might not be possible.
To put this bluntly, there is a massive risk of mortgage default if this were to happen next year: already tough times would become impossible for many households.
Now let’s look at this from the bank side. If we split the difference on the cost increase noted above and assume everyone will eventually pay the average increase of £615 a month on 6.8 million mortgages, this comes to £50.2 billion of extra income for banks each year.
What is the extra cost to the banks? Mortgages are refinanced by banks: they borrow money for shorter terms than they lend it. This means that their costs of providing these mortgages will rise.
However, assuming there are no mortgage defaults (a very big assumption) please do not have not a shadow of a doubt that additional profit margins will be earned by banks as a result of this massive increase in mortgage rates: that’s the way the system works.
And then there is another dimension to this. The biggest asset after mortgages that many banks now have is the cash that they hold on deposit with the Bank of England. In 2008 these balances amounted to around £40 billion. Now they are well over £900 billion.
This increase is easy to explain. Quantitative easing inflated the bank’s cash balances. This was money the government effectively spent into the economy and never taxed back, meaning it stayed with the commercial banks instead, and they have saved it with the Bank of England.
The Bank of England pays its bank base rate on these deposits. When the rate paid by the Bank of England was 0.1%, not very long ago, that meant that the cost of these cash deposits (effectively paid by the government) was less than £1 billion a year.
If the interest rate moves to 4% the cost will exceed £36 billion a year. And that, let me be clear, is all profit to the commercial banks that will be entirely paid for by our government.
What else could be done with £36 billion? By itself that would be enough to eliminate most fuel poverty in the UK – and so keep household energy bills manageable for every household but the wealthiest in the UK (and they’re not in fuel poverty anyway).
But instead of doing that the Bank of England will be requiring that the government give that £36 billion to our banks instead.
And whilst the banks profit, the rest of British business will not get the support it needs to survive, schools will go bust as they will be unable to pay their energy bills, care homes will close for the same reason and the NHS will fail.
Meanwhile, we will have a housing crisis that will also impact the rental sector, as rent increases are closely related to interest rate costs. Tenants will be in crisis too.
Despite all these disastrous outcomes, the financial markets have now priced in a rate rise to 4% by next May meaning, in other words, that they think that the Bank of England is mad enough to increase its interest rate with all these consequences being likely.
And actually, so do I think that they are that mad because there is no evidence to persuade me otherwise.
So, if you have a mortgage or are renting and you thought the energy bill cost was going to create a crisis for you, you ain’t seen nothing yet, as the saying goes. The insanity of the Bank of England is set to drive you into insolvency and out of your home, with nowhere to go.
Alternatively, we face a total financial collapse as the commercial banks seek to profit by maybe £50 billion or more a year whilst the world collapses around them. This is the economic insanity we are facing that the Bank of England might deliver.