Whatever the idiosyncrasies of the pandemic, how did we end up with a situation where small rises in interest rates – a key tool of monetary policy – could raise such serious concerns for the macroeconomy? Thus, while a return of interest rates to a historical norm of 4-5% seems highly unlikely, a rise to 2% is more feasible but could still have damaging impacts on the economy, weakening consumer confidence at a time when the government may be trying to reduce spending or increase taxation due to worries about the public deficit. The government’s promise of a state guarantee of mortgages worth 95% of a property on homes worth up to £600,000 will increase the size of this vulnerable group.įurthermore, the Bank’s own research suggests small rises in interest rates could contribute to falling house prices as property suddenly becomes less attractive to investors compared with safer assets like government bonds. These groups are also more at risk from job losses with the end of the furlough scheme. The Financial Conduct Authority estimated that a quarter of all adults in the UK have low financial resilience, defined as having “little capacity to withstand financial shocks”. There is a “long tail” of low-income households with high levels of debt – including unsecured debt – for whom even small increases in interest rates could make a material difference to their disposable income and spending power. That would put the Bank in a difficult position, since although average household debt-to-income ratios have fallen since the 2007-08 crisis, its distribution across different socioeconomic groups is far from equal. There is certainly a case for “wait-and-see”, given the third Covid wave that is now washing across the country and the proposed end of the furlough scheme in September.īut it is possible to imagine scenarios whereby inflation becomes more sustained, in particular if it continues to rise in economies such as the US and eurozone, with which the UK has close trading links, and if oil prices keep rising as global demand for energy or travel rebounds – or if the economy suffers ongoing shortages of labour due to Brexit-related issues that drive up wages. The Bank has tried to calm such fears, arguing the recent surge in consumer prices was “transitory” – the result of the unusually rapid recovery in economic activity that has followed the reopening of the economy – and that as a result it has no plans to raise rates. Most obviously, rising inflation could lead to the Bank of England raising interest rates. Banks are also much better capitalised than they were in 2007, meaning a fall in the value of housing – which they hold as collateral against their mortgage loans – will be less likely to impact on their lending activity.īut in the medium term, the risks could be more severe. Alongside the savings that have been built up, this means that falls in people’s housing wealth should have less of a negative impact on consumer spending. Household debt (including consumer debt) is lower relative to incomes and so are interest rates on that debt. The ultra-low interest rates and expanded quantitative easing programme of the Bank of England has also fuelled this credit binge.īut how much harm will the bursting of this bubble do? In the short term, the wider risk to the economy at the aggregate level from a fall in house prices looks less severe than in 2008.
Mortgage credit has grown at record rates, expanding from -£280m in April 2020 as the first lockdown kicked in, to its highest ever rate of £11bn by March this year. A more pessimistic scenario is that the end of the stamp duty holiday will puncture a huge mortgage credit-driven housing bubble that will ripple through the financial system and damage the nascent Covid recovery.
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