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.
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The author writes:
You mean the cost of re-financing a mortgage? Basically very minor admin costs. The banks don’t borrow money, they create it by a few keystrokes, they credit one account and debit a second one. They do NOT get physical pounds from their vaults! They do not take money from a short term loan and apply it to a mortgage. And don’t say they are required to cover their loans with physical dollars in a vault. They aren’t.
This lack of physical-ness is clear in the author’s point on how the BoE will pay billions to the commercial banks. I would ask where is the UK government in all this, but after 6+years of Brexit theatre I know the government is not concerned with governing but with enriching their 130K Tory members.
I think that Mr. Murphy is saying that banks tend to create loans using short term debt and charge higher interest rates on long term mortgages. Northern Rock went bust doing this if you recall. They re-financed their debt in the short term debt markets and when short term rates blew out they were bust as they could no longer re-finance. It has nothing to do with cash or pound notes from vaults.
I guess that they (represented by the Fed and the Bank of England) really do not mind mass misery and death. Maybe they also want to buy all those foreclosed houses much like PE has done in the United States already. People either sleep in the streets or pay even more for a rental and either way the investors make bank.
I read about stupid stuff done in the past reading history and I wonder why. Then this is happening right now and I still don’t know why stupid stuff is happening, the kind that starts wars, uprisings, and revolutions.
That is a fact!
this long and winding moment of “mass hysteria”…… watching this all , with no one interested in “other points of view”.. they would rather go down the rabbit-hole … every massive screw up… after another… and people are just “sure ” about all this “stupid stuff” . WTF?
there is no confusion about this period. the people who came to power in 1993 are fascists. under fascism whats mine is mine, whats yours is mine, and there will be no discussions period.
they are the hammer, everything else is a nail. when you understand this, then you can understand what appears to be irrational.
The pain of paying unaffordable electricity and natural gas bills is clear. It is not clear if UK has 30 year mortgages or if they have variable interest rates mortgages which were a disaster in the USA’s foreclosure crisis. These higher interest rates will terminated the sale of real estate.
This shows just how divorced Western Imperialists are from reality. No electricity, no heat, infrastructure damage and shortages of food are guaranteed to cause unrest. England and France have a history of revolts. Europe is at war and all they are doing is rising prices. There is no planning — no rationing or mobilization of resources and labor. No peace negotiations.
The 30 fixed rate, freely reifinancable mortgage is a global anomaly and exists only due to US government guarantees.
I do not like to seem to be coming down on you, but it’s not at all polite to raise an issue that you seem to regard as important and then not run it down yourself.
Your comment is tantamount to an assignment, which is a violation of our written site Policies, since you are basically asking someone to get an answer that you could have worked out yourself with a search engine. I take umbrage at having to spend time in comments addressing issues that never should have come up, since the readership is better served by having me work on new posts.
https://www.expatica.com/uk/housing/buying/your-guide-to-uk-mortgages-747470/
So shorter, there is no fixed rate mortgage in the UK as we think of them here. They have fixed interest terms for 2-5 years and reset.
And every time you re-fix your mortgage after the previous term expires they charge you another “arrangement fee”.
My father did somehow manage to get his bank manager to (very reluctantly) waive the arrangement fee when he took out a mortgage in the 1970s. Nowadays, probably only the bank CEO has the authority to waive fees, and even then only if you asked him nicely at a Tory party fundraising dinner.
We have a 25 year fixed rate mortgage on some UK residential property but it is unusual. It is from the agricultural mortgage company (onec a special purpose lender, then sold to Lloyds TSB) and the loan is overcollateralised, 50% loan to value of which half is agricultural land, and the rate is 4%. Only a small fraction of UK residential mortgages are on terms like these.
Picking up a comment below, we are about to sell these properties, we are clearly past the top of the market and, given we will be eating cold baked beans from the tin by candlelight in January, we are taking our capital off the table.
Plus there is a raft of tenant-friendly measures being introduced which will prevent us giving notice and which will force us to perform insane capital improvements to the properties (ancient rural cottages) in pursuit of the chimera of net zero. The EPC calculation ignores the insulating effect of curtains etc. so all the original wooden windows have to be ripped out and replaced with unmaintanable plastic UPVC double glazing which stops working after ten years when the seals go….
It could be worse, in France you are going to be banned from renting houses with low EPC’s OR raising the rent on existing ones (so no funding the works there!).
Our own house’s mortgage is a 5 year fix and I am just about to remortgage before it comes due in January 2023…. :-(
On the bright side, there were still rates of 3% available last week and for 10 year fixes.
At the start of the 90s UK interest rates hit 13%. That was also in pursuit of a failed policy which had been to maintain the value of sterling linked to ERM whilst at the same time running a higher inflation rate than Germany’s. There was lots of nuance associated with it, which I am sure others remember in greater detail but the fundamental issue was trying to maintain sterling and also hoping that doing so would control inflation via import prices. Outcomes were not good.
Seems this will have bad consequences too.
I guess a point that does need to be made though is that interest rates currently are very low by historical standards of the past fifty years, especially in real terms when we factor in inflation. Am not saying that the alleged wealth balance effect created by interest rate rises is a great or effective way to control inflation. It’s purely a theory and it is hard right see how it will work now.
However, at some point we were always likely to need to wean ourselves off overly cheap money and the sugar bursts of quantitative easing that have provided a nice subsidy for banks and other financial capitalists. As ever though, any such rewinding will always be painful. This feels bad timing and also not a smart way to do it either.
The late 80s / early 90s interest rate issues caused serious pain for a lot of people when the housing bubble of the time burst. My father lost a significant amount of money as the market turned; he had been a lifelong Tory previously but then deliberately abstained in 1997. Never voted for the Tories again. It will not be enough for Truss (the likely incumbent) to claim in the next few months that the Bank of England is “independent” (seriously?) and takes these decisions. Combined with energy prices, food prices and a pointless war that has gone totally wrong for the west (which surely will get harder to hide), we are heading for a very tough winter.
I am not sure about the rent thing. Landowners wanting to pass rent hikes to tenants might find it uneasy. Yet according to this July report from GLA in London asking prices have been increasing to a annualized rate of about 15% but most of the rise took place between Q3 and Q4 of 2021 while the curve is now clearly flattening even if demand seems to be above demand.
Interesting times ahead if we consider ‘interesting’ as synonymous to bad.
For those in the renting market about 34% of income goes to pay the rent according to the report. The battle to get more and more from incomes is going to get hard and winners might risk facing guillotines at some point.
Neoliberal economics will not die with a whimper, but with a bang. The adage that “the role of government is to enrich the rich” is getting pushback in almost every western economy in multiple ways. My rhetorical question has always been will it basically take collapse to cause change, or can we smoothly transition to more balanced societies?
It appears that the elites that control the levers of power are betting that they continue the game even as the masses face a truly bleak winter. At some point this will be a bad bet. When, as the author says, for a relatively small amount of money UK society can get through the winter and they opt not to do it… well then don’t be surprised by the reaction.
Richard –
“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.”
The extra 2 million homes are the speculative foreign/domestic ownership, bought with money funnelled in through the BVI etc. UK housing is increasingly a speculative market, with ‘investment’ from overseas driving prices up and keeping houses empty…
Particularly interesting, thanks!
They lure people into debt with low interest rates and steal their wealth a few years later by raising the interest rates. It’s all so genius. Diabolical.
I follow UK news closely and when Brexit passed, I thought “Pass the popcorn, this movie will deliver endless entertainment.” Now, I realize that this is a bit cruel, but Brits have voted (realize that a minority of voters did NOT vote for Tories/Brexit) for Tories and Brexit and now have the result of their vote in front of them.
The question, the big question, is “Are the Brits going to revolt against their government?”
Nothing else will make a difference. Take to the streets or do nothing…and signal that more beatings will be meekly accepted. BTW, a big fan of the Railway union leader whose plain speaking has completely gutted the commentariat at BBC and etc. He gets the effectiveness of direct action.
Ominous times in the UK. But so much of what happens in the UK happens here a bit later. I saw an article on NC about conditions (extreme classroom heat/cold) at a school in Ohio that mirrors conditions at some (many?) UK schools. The teachers there are going on strike, IIRC. My thought is to watch the UK as it’s a canary in our neoliberal coal mine.
Our travails are neither Brexit nor (current) Tories but 50 years of neoliberalism. Ni droit ni gauche mais les connards.
under brexit the people have the sovereignty to rebel, try doing what you propose being chained to the E.U. free trade zone, see greece, italy, spain, france, portugal, ireland, etc.
Not really. Recent leglislation like police powers act have essentially made rebellion (protest) illegal.
When the UK has pulled out of ECHJ etc, gonna be tough times to dissent.
rebellions can get messy sometimes. but if you are under the thumb of free trade as the colonies in the E.U. are, forget about any chances of change.
The UK had the pound. No comparison with the EUR countries.
exactly. the more sovereignty you have, the greater your abilities are to get rid of the vermin.
the reason why vermin like thatcher and bill clinton that were so hell bent on making their countries nothing more than colonies under free trade, is that they understood sovereignty, its the enemy of fascism.
https://www.huffpost.com/entry/nationalism-is-rising-not_b_10281138
“The nation-state is reasserting itself as the primary vehicle of political life. Multinational institutions like the European Union and multilateral trade treaties are being challenged because they are seen by some as not being in the national interest.
The charge of a rise in fascism comes from a profound misunderstanding of fascism. It is also an attempt to discredit the resurgence of nationalism and to defend the multinational systems that have dominated the West since World War II.
Nationalism is the core of the Enlightenment’s notion of liberal democracy. It asserts that the multinational dynasties that ruled autocratically denied basic human rights. Among these was the right to national self-determination and the right of citizens to decide what was in the national interest.
The Enlightenment feared tyranny and saw the multinational empires dominating Europe as the essence of tyranny. Destroying them meant replacing them with nation-states. The American and French revolutions were both nationalist risings, as were the risings that swept Europe in 1848. Liberal revolutions were by definition nationalist because they were risings against multinational empires.”
When can we say that the central banks are engaging in alchemy? They seem to be trying to create energy and products by raising interest rates.
When are the government going to do things like rationing plans, invest in new energy, and other real acts to deal with this crisis? Or are they doing these, but it’s not being discussed?
I realize that this current crisis has been many decades in the making, but there seems to be no real action to deal with it. Smells like failed state.
Nail, hammer.
Do we expect the rising of interest rates, in this environment of debt saturation and dependence, to have the same cooling effect it did in the early 80’s under Volker? Or does the raising of rates now further inflation? I would argue the raising of rates increases costs in the future both for new loans and loans that are rolled over. The cost to carry obligatory debt goes up. Federal “relief” with loose fiscal policy just furthers the debt dependence. Isn’t this another expression of “Modern Monetary Theory?” Are we now in the inflationary spiral?
This from a biology major. Someone in macro econ please help.
debt that can’t be paid back, won’t be paid back. that iron law is happening all over the world now. this will of course strike fear in the financial parasites, who will then double down on those whom they feed upon thus exacerbating the problem ever more till collapse.
russia, china, and the deplorable will be blamed, and promptly taken care of, the beatings will continue till the debt is serviced.