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. ENDS
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Which part of this don’t you understand? If base rates go up, the cost of borrowing for banks go up too.
If banks aren’t getting paid market rates on their deposits with the Bank of England then they will move that money into other assets which are paying the market rate.
To pretend that this is pure profit is an outright lie.
Oh dear
You really do not know that the banks cannot move their central bank reserve accounts anywhere else, do you?
If you’re going to comment as a smart arse it’s best to be right
So you think that banks should be forced to hold loss making deposits with the BoE and will not then seek to increase margins in other areas of their business?
Do you understand about businesses needing to make profits to pay their shareholders?
First, you really do not understand this issue
Second, as a person with a really quite successful commercial career I most certainly understand profit. I doubt you do
Sorry Nigel but you really did deserve that.
This might help you educate yourself on the topic:
https://www.bankofengland.co.uk/-/media/boe/files/ccbs/resources/understanding-the-central-bank-balance-sheet.pdf
‘While it is true that an individual commercial bank is free to choose between reserves and other
assets…’
An individual bank can but the commercial banking system as a whole cannot
Sorry, but stop making a fool of yourself
I never said otherwise. It was you that said banks couldn’t move their reserve accounts anywhere else, when they clearly can, as I already explained.
So explain why you think banks (in aggregate) should be forced to make large losses on their central bank reserves, and why you can’t see that they will simply increase margins in other areas to make up for it?
Just go and learn what central bank reserve accounts are and you will see how daft your question is
Please don’t call again
“An individual bank can” ..so a Bank can then, as banks act and make decisions individually not collectively as a sector.
Only if another bank agrees
But since they need these reserves you again show your lack of understanding
But the unspoken issue here is that banks have an option of exiting the market, which is bad for the market itself, no? You can only get away with forcing banks to take losses on their core model for so long…
Tell me what loss the bank is taking when QE funds were provided free of charge to the banks in the first instance?
And, perversely, in the current scenario hiking interest rates could make inflation worse according to Joseph Stiglitz:
https://www.bloomberg.com/news/articles/2022-08-24/stiglitz-says-rate-hikes-that-are-too-steep-may-worsen-inflation
The ‘average’ outstanding mortgage is mind boggling, especially bearing in mind that there will be many with much lower balances close to maturity.
Building costs have only risen in line with RPI, and considering that an average house price was about three times earnings for the period from the mid 1940’s to mid 1980’s where has all that increase in prices come from?
4%?
So its not only choice and price competition that has failed in the energy market, it’s also going to fail in the mortgage market and the much vaunted ‘variable rate’ mortgage – sold as a choice enabler to borrowers, but just a means to gouge out more profit opportunistically for lenders.
The Neo-liberal dream world is all coming undone.
If the BoE does that, it could contribute to bringing the Tories down – mortgages are a very sensitive area.
Personally I think the Tories are toast right now.
If Truss gets in and cocks at a snoop at the Northern Ireland Agreement, there might very well be a backlash of really bad proportions.
And what about what she said about Macron?
The Tory party is about to go from the frying pan into the fire if this loose cannon gets the PM role. And so are we by all accounts.
[…] 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 […]
So let me get this right. The banks had £40billion in reserves in BoE 2008. The BoE go on a printing spree and the banks kept cash to the tune of £900billion and now the BoE will need to pay billions in interest payments to the banks? So banks were given £860billion from BoE in QE and now make another fortune in interest? Have I got this right?
Yes
Not even close.
Did you conveniently forget about the £900 billion of Gilts which the banks previously owned and on which they were receiving interest, which were exchanged for the QE cash?
The banks owned almost none of them
They acted as conduits for the flow of funds for their sale, that is all
You really do need to get your facts right
I thought all that QE dosh was supposed to be loaned out to keep businesses afloat, keep an economy rolling, keep people employed – not sit on the bank’s balance sheets.
I wonder just what percentage of QE was passed on in business loans/funding ?
Try
https://www.taxresearch.org.uk/Blog/2022/06/17/how-are-the-central-bank-reserve-accounts-created/
And https://www.taxresearch.org.uk/Blog/wp-content/uploads/2022/06/How-the-central-bank-reserve-accounts-work.pdf
And https://www.taxresearch.org.uk/Blog/2022/06/21/the-double-entry-behind-the-money-creation-in-the-central-bank-reserve-accounts/
Cheers Richard, that helps.
I saw El-Erian being very critical of central banks in their analysis and of their communication which I concur. We all know that we cannot kill this inflation with higher rates but central banks have become unpredictable, maybe they don’t care about a hard landing anymore, maybe they will hike us into stagflation. I do not know anymore whether they are sticking to their blind mandate of 2% inflation or whether they still care for data dependency. Powell and Bailey will be remembered the same way as Greenspan – a litany of errors
Richard, how do you respond to those who say the BoE must follow the US Fed in increasing interest rates so as not to depress the £ against the $, which would further increase energy prices? I don’t know enough about FX to judge whether this is outweighed by the very real concern you express about mortgage rates and other related costs.
Why should we trash our economy because the US is seeking to do that?
Do you really think people should die for the exchange rate?
And how far do you think it would change?
Priorities…
Cheers.
First, what do we mean when we say the BoE raises rates to 4%? It is not some BoE diktat that requires banks to charge higher rates rather it acts in the open market to achieve higher rates. Open market operations comprise “lending” if rates are too high or “borrowing” if rates are too low.
Traditionally, pre-QE there was generally a shortage of reserves in the system and trend nominal growth meant that on average, the BoE was adding reserves to restrain rates from rising too high. QE has changed all that.
We can argue the merits of 4% rates but this is what is embedded in the SONIA Swap market which is the best liquid, undistorted market for determining rate expectations. If the BoE felt this was an incorrect assessment, then I am sure they would let us know.
If the BoE wants the SONIA (Sterling Overnight Index Average) to go higher it must “borrow” at the higher rate either through gilt sales of interest paid on reserves. If it does not do this then higher rates will not get transmitted to the wider economy and the BoE’s monetary policy will fail.
I agree that Reserves can’t “leak” out of the system. Also, that there is no rule that says the BoE must pay interest on excess reserves….. but paying interest on Reserves is the way the system works at present.
In the past, this has not been an issue as the level of reserves held by commercial banks has been small (pre-2008) or rates low (post 2008). But now it is an issue because banks will be making ever greater profits as the public suffers. But let’s be clear, the greater profits are due to higher rates not being passed on to savers. In the past, low rates for savers were the quid pro quo for “free” banking and the model worked when reserves were low but at £900bn it does not.
There are 4 possible solutions
1) Keep rates at zero. Then the payment of interest on reserves becomes a non-issue.
2) Raise reserve requirements. Make banks holds a greater level of reserves (on which no interest need be paid).
3) Force banks to pay higher rates to savers. Eg. Pay a minimum of bank rate -1% on all liabilities, but are savers the worthy recipients of this largesse?
4) Tax the excess profits derived from higher rates.
Thanks
All points worthy of consideration
I suggest the use of special rather than central bank reserve accounts
£100 billion on central bank reserve accounts should be enough to transmit rate intentions. The rest could be on special BRA with interest at 0.1% at most
On the surface I think this looks a good approach but I fear there considerable technical issues that might make this difficult. The current set up is all based on the premise that all draining/adding of reserves happens at the policy rate (interest on Reserves) or a market rate (gilt sales). Draining at 0.1% (which is, in effect, what you propose) raises issues that I need to ponder more…..
Please do
I think it little different to requiring more reserves
Let’s remember that the govt have massive exposure to any house price slide involving the ridiculous Help to buy scheme that has only driven house prices higher. The govt exposure of 20% of the loan after the buyers 5% lets the banks off the hook unless prices plunge more than 75% of the loan value. The buyer is not required to bear any losses from the govt (us) 20% share of the loan if the property is sold for less than the value of the loan. UK taxpayer exposure – billions I’d suggest if the housing market collapses.
I had forgotten that…..
Thanks
I agree, creating “Special Reserve Accounts” looks very similar to just raising (unremunerated) reserve requirements.
There are a few things to think about (for either)
Is £800bn the “right” number for special reserves? We don’t know – although a policy could easily be introduced and ratcheted up until we see some sort of equilibrium level reached that transmits higher rates to the economy. Indeed, the MPC meeting would contain two announcements – the interest rate decision and the Reserve decision.
How are the £800bn of “special reserves” distributed among banks that hold reserve accounts with the BoE? It needs to be a fair, transparent mechanism that does not distort a bank’s activities unduly. This is difficult and the “law of unintended consequences” might apply as we see banks (say) stopping some lending as a result. But perhaps it is an opportunity? Can we get a system that rewards “good” lending and penalises unproductive lending? This would be a big step as regulatory policy (to date) is merely concerned with safety of the banking system with no regards to the “usefulness” of the lending. I do think there is a way through this… but not with the current philosophy that prevails at the BoE. BIG changes would be needed.
What can these Special Reserves be used for? If the bank is obliged to hold them how do they fit into the Liquidity Regulations? Under the current system Central Bank Reserves are the most highly prized of liquid asset. If Special reserves were required it would potentially alter a bank’s LCR and NSFR and, in turn, change what business a bank would do? Again, we don’t know but I think that if we said that Special Reserves are always good collateral against BoE operations then it should work.
Clive
Apologies for me taking time to get to this. By late afternoon I am still wiped out at present, and so duck serious comments until time permits if they arrive after then. Thankfully four weeks of antibiotics finally seem to be working.
Lots to muse on here: comment much appreciated
No apology needed. On the contrary, I am staggered at the attention you pay to this blog despite illness and other work.
I learn here
Sometimes even from the idiots
Knowing what the idiots think matters
But they, unlike others, never change my mind
Yes it is crazy.
We might remember the dreams and prophesies of Moses from our school days. One of these was that there was going to be seven years of plenty followed by seven years of famine. Sensibly, the Pharaoh decided to store some of the grain in the years of plenty so that there would be some available for the years of shortage.
If he’d been advised by modern neoliberal economists he’d have been told to run a budget surplus with possibly a loose monetary policy during the good times but then tighten up with increased interest rates once grain prices, and others prices too as a consequence, had started to rise during the lean times.
More liberal economists, but still with neoliberal inclinations, would have probably gone along with eating all the grain in the good years but then favoured taxing the ultra rich in the lean years. This would only have worked, to some extent, if they’d then chosen to eat less.
The fundamental question of a lack of grain wouldn’t be properly addressed.
RM said
“I learn here
Sometimes even from the idiots
Knowing what the idiots think matters”
What a wonderful comment , made my day 🙂 And thanks to your patience Richard, I am sure there are a few less idiots around than there used to be. Myself included. I wish you speedy recovery from your lingering Covid problem.
Thanks
It seems I am finally beating it
I really hope so…..over 4 weeks on antibiotics now, which is apparently ok