This week I saw something I haven’t in a while: a brochure from Strutt & Parker advertising a price reduction on a rather charming Notting Hill house. It is now a mere £4,750,000 ($6 million) — down around 6% from its original listing price. And that might not be the end of it.
You’d usually expect houses in Notting Hill to be snapped up in minutes, but run your eye down a list of nearby houses for sale and you will see little snapping up going on. There are a good few that were listed in May — even one from December (now yours for £5,750,000, with monthly mortgage payments of roughly £25,000) — that still hasn’t sold. There will be more of this. Much more.
The average interest rate on a two-year fixed-rate mortgage has just gone over 6% — that’s many multiples of the cheapest offerings you could have found only two years ago (well under 2%). And the latest UK inflation numbers suggest there is more pain to come: CPI in May was 8.7%, and core inflation came in at 7.1% (up from 6.8%), which is the highest rate since 1992.
The futures market is now convinced the Bank of England will raise interest rates by a quarter-point to 4.75% on Thursday and sees a peak rate of 6%. The days when almost everyone thought rates would top out at a maximum of 4% are long gone.
This is horrible for mortgage holders. Income-to-debt ratios are so high that rates at 6% today are far worse for borrowers than the double-digit rates of the early 1990s were. There’s a lot more debt to pay these rates on. So what next? There is a growing consensus that something must be done — that the state must step in to ease the pain. This is entirely wrong-headed.
Consider the possible ways it might do this. The government could reintroduce some kind of mortgage tax reduction. It could hand out cash lump sums to mortgage holders to help them out in much the same way as it did with energy bills. Or it could perhaps intervene directly in the mortgage market — the state could work with banks to provide lower-cost mortgages or loans to homeowners, rather in the style of the Covid business interruption loan scheme.
All these things help only one part of the population — and a reasonably well-off one at that. What of all the other groups suffering from high-interest rates? Think of the tenants seeing their rents soar as buy-to-let costs rise and of small businesses seeing the rates on their loans do the same. You might also ask, should you decide to give money to all those in trouble, what you might do with those who are doing just fine out of rising rates and inflation — such as savers who own their houses outright, those who have managed to get a 10% pay rise out of their employers, and public-sector pensioners on index-linked defined-benefit pensions.
If we give cash to those in trouble, should we take it from those who are not and even things out a bit? You see the problem.
It just doesn’t work. But there is another more important reason why this can’t happen — because causing pain is the actual point of putting interest rates up. It is the recession that brings down inflation — creating the fear, uncertainty, consumer financial constraints, and fragility that stops employees from demanding price rises, businesses from putting up prices, and everyone from spending. The point is to create slack. That’s it.
Yes, it’s a nasty business — but that’s how it’s meant to work. Central bankers are supposed to take the punch bowl away when the party really gets going. If they do that but simultaneously sneak tequila slammers to the giddiest of the revelers, the results will be unpleasant. Protect people from the consequences of rising interest rates and you might as well not bother putting them up in the first place.
The truth is, we will not be able to sort this out in the short term. We are, I am afraid, where we are. But there is one thing we must do urgently: We must have a good look at the role of the Bank of England.
Back in 2021, Governor Andrew Bailey insisted that the nasty-looking price rises were transitory and all about global supply-chain troubles that had nothing to do with his organization. The forecasts he used to back this up have turned out to be some of the worst in the history of economics. At every turn, the BOE’s models seemed to suggest that CPI would be back at 2% in the blink of an eye. Nothing to see here guv. As a result, the central bank did not start raising rates from their lows of 0.1% until late 2021, many months later than perhaps they should have.
What went wrong? Ask any of the economists who said in 2020 and early 2021 that inflation was coming — at speed — and you will get the same answers: groupthink, an odd lack of imagination, bad models, and, crucially, a failure to think about money supply.
James Ferguson of the Macrostrategy Partnership says to consider this simple fact: Since March 2020, the UK money supply (as measured by M4ex, which calculates broad money but excludes holdings of some financial institutions) is up around 20%. Over the same time period, prices have also risen 20%. It’s countries that “did not resort to Covid money printing” that have not seen double-digit inflation. Think Japan (3.5%), China (0.2%), and Switzerland (2.2%), for example. This is not to suggest that global energy and food prices are not part of the equation in high-inflation countries — they are, of course. But it is the money printing that allowed people to pay those high prices without cutting back elsewhere.
A central bank that cannot see the risk in its own money supply numbers might be doing a less-than-optimal job. The BOE accepts that its models aren’t quite what they should be and is planning to have an external expert review them. But this is too little, too late, as anyone whose living standards are being destroyed by 8.7% CPI and 6% mortgage rates will unhappily tell you. The whole idea of central bank independence needs to be looked at again — if it is this that has turned the BOE into a bastion of academic groupthink, maybe we haven’t got it quite right. Alternative thinkers need to be brought into the tent and actually listened to.
Confidence in the BOE is at a record low, which hugely limits its policy options. If it had the trust of the general population today, it could hold off from another raise tomorrow on the basis that prices are obviously plateauing or falling in many places (note the brutally competitive UK supermarkets are cutting prices), and that the money supply is waning — down 3.5% on a seven-month annualized basis and up a mere 1.7% year over year, says Ferguson.
Inflation isn’t simple, and neither is monetary policy. It is particularly hard at the moment: With lots of houses owned outright, most people on fixed rates of some kind, and interest-only mortgages relatively rare, putting interest rates up doesn’t work as well or as fast as it once might have.
Last April, two in-house BOE economists wrote a book called “Can’t We Just Print More Money?” In it they say, “Central banks can print more money up to a point. But not endlessly — at least the economy falls into another age of uncomfortably high price increases, and we fail to hit our inflation target. Increases in money must be just right.” If Bailey is planning to stay on as governor, he and his immediate team might want to spend a few hours reading this primer on economics. Or perhaps re-reading. He wrote the foreword after all.
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