“Where does it go from here?” asked Haircut 100 back in 1982 and that’s exactly what borrowers have been asking after Bank of England (BoE) Governor Andrew Bailey’s MPC (Monetary Policy Committee) hiked rates to 5.25%, the 14th increase in just two years.
The UK’s base interest rate is now higher than it was in 2008 just before the collapse of Lehman Brothers plunged the world into the Global Financial Crisis.
The BoE, along with just about every other central bank around the world, is charged with keeping inflation at, or around, 2% per annum, an arbitrary figure introduced by New Zealand in the late eighties.
Why a country with the largest ratio of sheep to humans in the world (it was 22:1 in the 1980s but has declined to around 5:1 today, still much higher than the UK where there are considerably less sheep than people) became the bellwether for effective monetary policy among the world’s biggest economies is a mystery, but irrespective of how we came by it, the 2% target is now embedded in the psyche of consumers everywhere. Breaking with the 2% inflation goal is taboo.
Any central banker that even contemplates such sacrilege will be warned of becoming the next Arthur Burns, head of the US Federal Reserve between 1970 and 1978 and the person that has the ignominy of being regarded as the man who let inflation escape on his watch.
Andrew Bailey, a Cambridge history graduate, will be acutely aware of the 1970s and will want to avoid poor Burns’s fate. For the BoE, the reputational risks from inflation getting out of control outweigh the risks of a recession as the latter can be explained away by external factors beyond the Governor’s control. No wonder then, that having been liberal with QE (Quantitative Easing) in 2020 and being slow to react to rising prices in 2021, the BoE is now engaged in a race to the peak of the interest rate mountain, where it can plant its flag and claim victory over inflation, even if the economy is left in tatters.
Borrowers have borne the brunt of the UK’s recent rapid increase in base rates, especially those that have a variable rate mortgage, or are at the end of their fixed rate term. Lenders are charging much higher fixed rates than just a couple of years back, but there is light at the end of the tunnel. Across the pond, US inflation is tumbling, and the Fed is likely at the end of its hiking cycle.
At home, inflation seems to be retreating from its 11.1% zenith of October last year and as previously massive increases in the costs of energy fall out from the one-year figures, our Prime Minister and BoE Governor are likely going to fulfill their promises of halving inflation by the end of the year.
So, what’s the bottom line for borrowers? This current bout of inflation was caused by four things:
- The Covid motivated shutting down of the global economy damaging supply-chains.
- Tensions between China and the US slowing/ending globalisation.
- The war in Ukraine driving up energy prices to unanticipated levels.
- Central banks opening the money taps in 2020 and being too slow to shut them after consumers became awash with cash.
No. 1 is well and truly passed. 2 & 3 may be with us for some time to come, but the global economy is adjusting to them and the speed with which Germany tacked away from Russian gas to other sources of energy has been nothing short of miraculous.
As for 4, I suspect central banks have now done enough to convince the world that they are serious about controlling inflation and that interest rates have peaked, so personally, I would not be fixing the rate on my mortgage just now as I suspect a lower rate will be available early next year (but please, please consider your personal circumstances before making a decision and take advice from a specialist) especially if the UK’s economic growth continues in its present lacklustre fashion and at a rate way behind most of our major competitors, and especially the Americans.
In short, all is not doom and gloom after all!