_Os_ wrote: Thu Jun 22, 2023 10:32 am
It's time for another interest rate post. First some of the facts...
1. Core inflation is up, overall inflation has not moved.
2. Interest rates are going up, because this is the lever the BoE has to control inflation (via supressing consumer buying power). This is all textbook (since Thatcher?).
3. Wages have been stagnant in the UK for 15 years, and in real terms declining for many.
4. The UK is now so heavily leveraged, that interest rate rises much gentler than in the past, are a much more onerous burden. There's a big difference between 5% on a £250k mortgage when the combined household income is £50k, than 5% on £40k with a combined income of £15k-£20k. That's without factoring in reduced spending power now compared to the past.
The direction of travel does not look good. Put bluntly, raising interest rates looks incapable of reducing inflation in 2023 UK (I'm not referring to the past with that statement, only the here and now), yet that's where the BoE (and the government which ultimately controls it) is heading. What I'm seeing is higher interest rates fuelling inflation.
Facts 3 and 4 are crucial to understanding the problem. Wages have not been going up at all or enough to create inflation, so using interest rates to supress spending power isn't going to do what the BoE want it to do (reduce inflation). And the UK is now so indebted that debt interest payments are a significant outgoing (both in personal finances and in small businesses), unlike in the past when there was less indebtedness if the interest rate rises now so do costs everywhere, all the costs incurred to businesses by interest rate rises are passed on (anyone with their hand in the game, can see it in real time). Consumers then stop spending on anything they don't have to (hospitality and the high street go under etc), but they also start demanding pay rises to service their own debt and not just to afford to live.
Interest rate rises also don't supress spending power equally. Anyone with their mortgage paid off and a large amount of savings will have their spending power increased in absolute and relative terms. This will mostly be older people. Anyone with a large mortgage and little savings is probably facing going under entirely if interest rates go north of 5% and stay there. This will mostly be people under 40 (and a specific subset of that group, those that did well enough to get a mortgage, will be punished for that). So there's also a huge wealth transfer mechanism from the young to the old built into this.
Another fact:
5. Economists including at the BoE haven't made forecasts that have been particularly accurate. They then make a new forecast and pretend the old one didn't exist. Interest rates at one time were supposed to peak at 4.5%, inflation was supposed to be falling much more than it is, core inflation wasn't supposed to be climbing heading into mid 2023.
A lot of what's going on seems to be ideological, economics is more ideological that it's often presented. What I'm seeing is a square peg that's being hammered into a round hole, despite that fact it doesn't seem to be working, because of ideology. Truss was the most extreme proponent of the dogma to get into power, but it's also the consensus view if more diluted, as such it's worth rewinding to Truss' time in power ...
Team Truss were in favour of interest rates much higher than they are now (that was their answer to anything regarding inflation). They believe in the power of the market, the market is almost a god to them. They do not believe that businesses can set prices, they think the market does alone (most of these people have never run a business of any size), so they thought increasing borrowing costs would eliminate what they saw as unproductive businesses making the UK economy stronger. They don't understand that this worked in the past when some businesses were heavily indebted but most weren't indebted at all, which isn't the case now (what's true in the housing market is true across the economy, you have to go into debt to compete with those willing to take debt on, if you don't do this and have no other funding the business will fail before it does anything). Nor do they understand that businesses actually do have a large say in setting prices, and this becomes more true the larger they are/the more of a monopoly they hold. Team Truss also have an ideological blindness to the possibility something within government control (interest rates) has the power to set the market, because they don't believe the state should have the power to do anything and certainly not control their god.
If I'm right and it's all actually ideology and detached from reality, how high can interest rates go? 7%? 8%? 11%? A lot of people below 40 will be hurting at 5%, anything prolonged over 7% and they're wiped out.
Great post