PENSIONSANDSAVINGS.COM

• Brilliant for powerful groups but has caused economic distortions and increased inequalities
• Each £100,000 mortgage now costs £3300 a year less, saving borrowers about £19,000 since 2008
• Savers with £100,000 in Cash ISAs lost £4000pa income and lost total of £18,500 since 2008

What happened 5 years ago?  On March 5th 2009, the Bank of England cut interest rates to 0.5% and started creating billions of pounds of new money from thin air (calling this ‘Quantitative Easing’ or QE) which it spent on buying government bonds (gilts).

Why did this happen?  It seemed that the economy was heading for depression and deflation as banks stopped lending to each other and markets were in turmoil.  These policies were supposed to be short-term emergency measures to stave off a depression, with the aim of encouraging banks to kick-start lending and consumer spending to promote economic recovery.

But the economy has recovered, so why are rates still so low?  These policies have benefited many powerful vested interest groups, so they have remained in place even as the economy has recovered and no longer needs such ‘life-support’.

Who benefits from QE and low interest rates?  Some very powerful vested interest groups – when you look at those who have benefited, it is clear why the policies have such support:

• Government – The Treasury has been able to borrow much more cheaply as the Bank of England’s £375billion of gilt purchases reduced bond yields
•  Banking sector – has benefited from the financial flows of QE new money and much of the new money has bolstered their balance sheets and boosted bankers’ pay
• Wealthiest groups – have profited as financial markets have risen
• Highest earners  – especially in the financial sector – have benefited as markets rose
• Big corporations – have borrowed very cheaply as QE brought corporate bond yields down and large firms now have record high cash to spend if they want to
• Homeowners in the most prosperous areas – as house prices rose sharply boosted by more mortgage lending
• Those with mortgages – the larger your mortgage, the more you have benefited.

So QE and low rates are good, what’s the problem?  Many less powerful groups are hurt or have failed to benefit from these policies.

• Small firms who still cannot borrow on decent terms despite low rates – Bank of England figures just released show bank lending to small firms still falling
• Youngsters struggling to pay increasing rents and cannot afford to buy a home as house prices are boosted by low interest rates
• Older generations whose pensions and savings income are much lower
• Savers whose income has been cut dramatically
• Less well-off who have struggled with the cost of living, do not benefit from strong financial markets and cannot borrow cheaply despite low official rates
• Annuity-purchasers whose pension income will be permanently lower
• Defined benefit pension schemes whose liabilities have increased by far more than their assets (sometimes bankrupting their sponsors).

Why have these negative impacts been ignored?  The negative effects of low rates and QE impact sectors with lower political leverage.   The worst impacts are likely to come over the longer term – indeed we may be building a giant financial bubble, but it will be future Governments that have to deal with the legacy of market distortions, inequalities and unrealistic expectations that are being built up by keeping rates too low for too long.

But financial markets have done well, isn’t that good for all of us?  Nobody knows what the ultimate effect of the Bank of England buying one third of all government bonds will be.  It is unprecedented to have such artificial distortion of the supposed-to-be risk-free asset.  Government bonds underpin the prices of other assets too, which may mean all assets are much more risky than before.  When the Bank sells the gilts it has bought, investors seeking safe assets are at risk of losses.  Even before this happens, investors in the supposedly safest bonds have lost over 10% of their capital since 2012 as markets feared the end of QE.

But mortgage borrowers are much better off isn’t that good for all of us? Only one third of households actually has a mortgage, while the other two thirds either own their home outright or pay rent.  The interests of those with mortgages have been driving the policy agenda but rising house prices lead to rising rents, which are particularly problematic for the young.

How significant have the effects of low rates been?  For mortgagees, the impact has been enormous.  For example, someone with a £100,000 Standard Variable Rate mortgage could have saved over £19,000 in lower interest payments since rates started falling.  Their mortgage repayments could now be around £3300 a year lower than in December 2007.  But keeping rates so low is merely prolonging an illusion of affordability and there are fears that many will not be able to afford even a small rate rise.  This could damage growth in future years.

And what about savers?  For many people, especially those in or near retirement, the effect of low interest rates has decimated their income leaving many facing severe income shortfalls.  Savers have little voice or power to alleviate their losses, or are being forced to take much more investment risk.  The policy stance has rewarded borrowers and punished savers – the message being sent is ‘you’re a mug to save’.  Those with £100,000 in Cash ISAs will generally have lost income totalling around £18,500  since 2008 and their interest income could be more than £4,000 a year less.  The following table summarises the income effects.

Interest saved on £100,000 mortgage vs. interest lost on £100,000 savings

	Annual interest Dec 2007	Annual interest Dec 2013	Difference in annual interest	Total gained/lost since Dec 2007
BORROWERS
£100,000 SVR mortgage	£7680	£4390	£3290pa gain	£19,000 better off
SAVERS
£100,000 savings in Cash ISA	£5350	£1090	£4260pa less	£18,500 worse off

Source:  Bank of England statistics, Table G.13 – (using closest comparable figures)

Has QE boosted growth? QE money has helped the financial economy rather than directly benefiting the real economy, and it is not clear that QE actually helped growth.  The authorities failed to ensure the newly created money was actually lent on to small firms or used to boost investment and infrastructure spending – using it buy gilts did not ensure the money reached the parts of the economy that needed it.  Small companies are still starved of credit by the banks – in fact Bank of England figures released yesterday show small firm lending still falling.  The main driver of growth has actually been consumer and housing spending, boosted by low interest rates and government schemes to bolster mortgage borrowing.   In addition, QE has damaged annuity rates and will leave millions of pensioners permanently poorer as, once bought, their annuities are for life.

But even if QE and low rates have helped a bit, aren’t they good?  Of course, it is true that these policies were better than not doing anything at all to boost the economy.  However, the authorities could have tried other measures but chose not to.  The problem is that these policies have had regional, social and demographic effects which many may think are unjust.  Indeed, income and wealth have been redistributed to the wealthiest groups and those with largest houses, increasing regional and income disparities.  Those living in the south have benefited much more than those elsewhere.  Borrowing has been encouraged while saving has been penalised. The financial sector has been boosted by the newly created money and rising asset prices.  If the government had tried to achieve these outcomes by cutting taxes for the wealthiest groups and cutting pensions significantly, there would have been uproar.  But monetary policy has done this without any Parliamentary or democratic debate.

What else should be done then?  Rather than continuing to rely on helping mortgage borrowers afford debts that they will be unable to service at more normal interest rates, it would have been better to use the newly created money to support direct investment in infrastructure and corporate investment rather than just buying gilts.  It will be important for the Chancellor to introduce incentives to encourage firms to spend their cash piles, perhaps with temporary tax breaks for corporate capital spending, since this will improve long-term growth rather than relying on more borrowing for housing or consumer spending, which are less sustainable in future.

Rates have been kept far too low for far too long.  Too many powerful groups have vested interests in keeping the monetary taps open.  As the economy is clearly recovering, rates should already be rising.  A small rise in rates is long overdue and would send a helpful signal to borrowers to plan for more normal interest rate levels.  Monetary policy seems much more about politics than economics, as politicians want the short-term benefits and leave future governments to deal with the longer-term losses.