28th February 2014
It is almost exactly 5 years since the Bank of England cut short-term interest rates to 0.5% and started printing billions of pounds to force long-term interest rates lower. Good news for some? Dreadful for others. Should rates be rising or stay where they are?
TEN REASONS TO REJOICE – these policies are great and have had tremendous benefits
- Borrowers have had a bonanza with mortgages getting cheaper and cheaper, encouraging people to borrow far more than they will be able to afford when rates reach more normal levels
- Wealthy investors have benefited from exceptional gains on their portfolios of bonds
- Gilt yields have fallen to record low levels which reduces interest costs on Government debt, thus helping the Government in its management of the economy through austerity
- The financial sector – an important part of the UK economy – has been boosted by official support that created flows of new money and allowed debts to be restructured or written off
- As the Bank of England has bought record amounts of gilts, investors have switched funds into other assets, both bonds and equities, but also emerging markets and real estate
- Top earners have seen their pay rise rapidly as companies have taken advantage of benign market conditions
- Stock markets have reached record highs, especially FTSE250, but even FTSE100 with dividends reinvested is well past its previous peak
- House prices have rocketed due to rising mortgage borrowing – most expensive homes have risen most in price
- Consumer spending has been buoyed up by borrowing
- Companies have record amounts of cash in their balance sheets and large firms have been able to afford to borrow on the bond markets at record low rates, due to the fall in gilt yields
TEN REASONS TO DESPAIR – despite benefiting some groups, these policies have caused serious damage
- The £375bn of newly created money has not been directed into small firm lending or investment in long-term growth projects – it has been used to boost bank balance sheets and financial transactions rather than real long-term growth projects.
- The banking sector has still not dealt properly with its problem debts and has not been lending to small businesses – instead it has focussed on increasing revenues from market trading and financial engineering, rather than investing in the real economy
- Monetary policy is lulling borrowers into a false sense of security and enticing people to take out loans that they will struggle to afford at ‘normal’ interest rates, so the policy is great for short-term benefits, but carries dangerous longer-term consequences. Instead of building a lasting recovery on new investment, the focus has been or pushing up house prices instead of building new homes and on enticing people to borrow to buy more houses – this kind of irresponsible borrowing led to the financial crisis in the first place.
- Low mortgage rates and rising house prices are not necessarily a ‘good thing’. Only one third of UK households have a mortgage. Those with mortgages have benefited significantly from a boost to their income, but those who are renting (another one third of UK households) have faced rising rents which have hit their standards of living.
- By distorting gilt yields, the Bank of England has interfered with the supposedly risk-free interest rate, thereby distorting investment risk in ways that investors cannot understand, while also increasing the volatility (risk) in financial markets
- Younger generations have suffered as rising house prices have led to rising rents and, as real wages have been under pressure and interest on savings is so low, it has become even more difficult for them to afford the costs of living. Unemployment and underemployment have remained problematic as businesses have failed to invest their cash piles
- Pension fund deficits have ballooned
- Annuity rates have plunged leaving millions of pensioners permanently poorer throughout the rest of their lives If you have reached retirement in recent times, your pension savings will buy you a much lower pension income than you would previously have expected
- Savers have lost most of their income and their capital has been eroded by higher inflation (boosted by QE) although price inflation has subsided now, with price rises moving to asset markets rather than goods markets. If you were expecting to live on your savings in retirement, low rates have been disastrous. The more you had saved, the more your income will have fallen
- National and regional income and wealth inequalities have risen significantly – National income and wealth has been redistributed from middle income to the wealthiest and higher earners, from north to south, from least prosperous areas to most prosperous and from older generations to middle aged groups
So what is your view?