The ‘Old Lady’, HM Treasury and the “Mortgage Crisis”

More Unwelcome News

On Monday morning (19 June) the yield on the UK government’s bellwether two-year gilt hit five percent, a level not seen since 2008. This came as the average cost of a two-year fixed-rate mortgage climbed above 6 percent for the first time this year as the markets awaited crucial inflation data on Wednesday and the outcome of the Bank of England’s (BoE’s) Monetary Policy Committee (MPC) meeting on Thursday. TSB withdrew a slew of its mortgage products altogether, following Nationwide and HSBC which suspended nearly all of their offers last week.

By midweek the markets were expecting at least a one-quarter-percent increase in rates, if not a more robust half percent. The Bank raised rates by 50 basis points from 4.5 percent to 5.0 percent further to disappointing inflation data out on Wednesday morning. Consumer price inflation in the UK is flatlining at 8.7 percent: there is no discernible downward trend. That means that the wage-price spiral is likely only to intensify as unionised labour attempts to preserve its spending power. Core inflation, which excludes the price of volatile commodities such as energy and food, actually rose from 6.8 percent in April to 7.1 percent in May. This was driven by increases in the cost of air travel; cinema and theatre tickets; computer games; and in the price of secondhand cars.

Further to the Bank’s thirteenth consecutive rate hike, the markets’ best guess was that UK interest rates would have to rise to six percent by the end of this year – much higher than estimates at the beginning of 2023. Mea culpa: Last Christmas I predicted 4.25 percent at year end, which now looks way out. Inflation in the UK remains stubbornly higher than in the US and in the major EU countries – which is why the UK government now borrows money at higher rates than Italy.

The Remain-inclined establishment, embodied by former BoE governor Mark Carney, blames the UK’s higher level of inflation on Brexit – even though food-price inflation in Europe has been equivalent to ours. The main reasons why our economy is lagging are our poor productivity and the post-pandemic contraction of the labour market. The latter has arisen due to widespread early retirement and long-term sickness.

Just for good measure, figures on Wednesday revealed that the UK’s debt-to-GDP ratio has now exceeded 100 percent for the first time since 1961. Government borrowing in the month of May hit £20bn – more than double the £9.4bn borrowed in May last year. That figure was driven by soaring benefits payments and higher wages in the NHS further to recent pay settlements.

The UK has now joined the club of grossly indebted countries, with little prospect that the trend can be reversed in the short to medium term. This comes at a moment when the cost of servicing that debt is soaring – the interest bill on the national debt will exceed the education budget this year.

UK Economic Policy – What Is It?

The UK is not in recession – as the BoE predicted last year we would be by now – but the economy remains extremely fragile. Growth remains feeble; the public finances are poor and getting worse; real disposable incomes are still declining as inflation outpaces wage rises – in fact they are now back to 2005 levels. One has to go back to the 1820s or 1830s to find a similarly lengthy period of wage stagnation.

And, as inflation persists, so the BoE feels compelled to raise rates further, thus causing pain to mortgage holders as and when their fixed-rate deals are renewed. That takes further purchasing power out of consumers’ purses and wallets, thus raising the probability of recession setting in over the short to medium term.

If the ‘Old Lady of Threadneedle Street’ does not raise rates in tandem with the Fed, the pound will sink against the dollar and the prices of imported foodstuffs and fuel will rise further in sterling terms, thus stimulating inflation. That would make recession more likely − especially given that the eurozone is already in recession on the back of negative growth in Germany.

The irony is that the politicians feel embarrassed to talk about monetary policy. The reason: since 1997 monetary policy has been the sole responsibility of the elite which presides at the BoE. The Treasury, which controls fiscal policy (taxation and spending) considers it improper to comment on the Bank’s decisions on rates or on control of the money supply via quantitative easing (QE) or quantitative tightening. Let’s recall that the last round of QE was as recent as November 2020, at the height of the pandemic.

But, as Michael Gove, currently secretary of state for Levelling Up, Housing and Communities, implied this week, the size of the fiscal deficit and the overall stock of government debt bear down on the base rate (the price of money in the UK). And the rate of interest determines the rate of economic growth which, in turn, drives the volume of tax revenues, and thus what governments have available to spend. So, in the round, fiscal and monetary policy cannot be separated – even though in most western countries their official separation has become the standard model.

The BoE has only one remit from government: namely, to ensure that the economy adheres to an inflation target set by the Chancellor of The Exchequer. That inflation target has been, since about 2008, two percent per annum. But it would be considered rude for the Treasury to point out that the ‘emperor has no clothes’ – or rather that the BoE has nakedly failed in its mission, with inflation in the UK still north of eight percent, or four times the target. The Bank has no remit to bolster economic growth – that is the task of the Treasury. But economic growth is ultimately determined by the deliberations of the MPC mandarins.

Then there is the Public Accounts Committee of the House of Commons and the full array of think tanks – The Institute for Fiscal Studies (IFS), the Resolution Foundation and the rest − which chip in perennially with their pearls of wisdom, eagerly disseminated by the wider commentariat. Note that much of the commentariat is made up of 30-and-40-something graduates who tend to be mortgage holders in the more salubrious suburbs of north London. They have skin in this particular game.

No one seems to be clear how long interest-rate hikes, once they are made, will impact the economy and by how much. There is always a time lag between cause and effect, and it is likely that the consequences of previous rate hikes have still not been made manifest.

So, economic policy in the UK (and elsewhere) has become a kind of Mad Hatter’s Tea Party in which the economy (Alice) is condemned to take tea with the Mad Hatter (the Bank), the Dormouse (Treasury) and the March Hare (the commentariat), with the clock perpetually stuck at six o’clock. The tea party is rich with unanswerable riddles and nonsense poetry, and lashings of tea of course; but is ultimately inconsequential.

“Crashing the economy”

The Labour Party never ceases to remind us that the Tories “crashed the UK economy” with the Truss-Kwarteng kamikaze mini-budget of September last year. I have lost count of the number of times I have heard Rachel Reeves and Emily Thornberry use this hackneyed phrase.

It is certainly true that Truss and Kwarteng had not primed the markets for these announcements and that there was an ensuing bond-market wobble – exacerbated by the so-called liability-driven investment vehicles in which many institutional investors were holding their portfolios of gilts. That was largely temporary and gilt yields subsided, although they have now exceeded their highs during the wobble – even if sterling has remained robust against the dollar and the euro.

But Reeves and Thornberry don’t seem to have noticed that interest rates have been on an upward trajectory across North America and Europe as well since the end of 2021, with consequential rises in government borrowing costs. The Truss-Kwarteng programme was one designed to reboot the UK economy in a way that would offer the prospect of higher growth going forward. Nothing advanced by either Sunak-Hunt or Starmer-Reeves is likely to boost the economy.

On the contrary, talk of price controls on essential foods (which I discussed here three weeks ago) and now of possibly giving state aid to distressed mortgage holders smacks of state socialism. Mortgage providers should have inculcated their borrowers that near-zero rates were unlikely to endure and that at some point they would snap back to historically more normal levels. But then, if the government is going to pay your gas bill, it may as well pick up the tab for your mortgage too. And indeed, that mentality is precisely the problem with the contemporary Britain.

The fact is that more than a decade of near-zero interest rates – a policy for which the BoE and its counterparts in Washington and Frankfurt were solely responsible – has damaged the economy. QE was highly regressive, boosting asset prices artificially while doing nothing for the less well-off. Lending to new businesses declined but zombie businesses which created negative value were kept alive, thus reducing future productive capacity. Returns for savers were negligible, thus punishing the provident and encouraging otherwise sensible investors to search for yield in dodgy places. When interest rates are at near-zero levels it becomes impossible for business managers to differentiate between outstanding and poor investment opportunities.

One reason why our level of inflation is running consistently higher than that of our near neighbour, France, is that successive UK governments, unlike the French, have not paid enough attention to the related themes of energy security and food security. That makes us much more vulnerable to external shocks. Our relative energy insecurity has only been made worse by the UK government’s commitments to net-zero carbon by 2050 and the banning of new petrol and diesel cars by 2030 – five years before the EU. Renewables are all very well; but we are still far from ensuring sufficient backup generating capacity for when the wind does not blow, and the sun does not shine.

The “Mortgage Crisis”

The UK is seemingly stuck in a permanent polycrisis. We’ve had the energy crisis, the cost-of-living-crisis and now a “mortgage crisis” or rather, in Sir Keir Starmer’s words, a “mortgage catastrophe.” I’ll put aside the obesity crisis, the diabetes crisis, the mental-health crisis and the loneliness crisis for another day − not forgetting, of course, the climate crisis.

At Prime Minister’s Questions on Wednesday, Starmer bandied the figure of £2,900 a year in additional mortgage interest payments per family – on top of increased energy and food costs. This figure emerges from a report out this week from the Resolution Foundation, which stated that 800,000 households would be forced to remortgage next year. The Bank estimates that 1.3 million mortgage holders will need to re-fix their mortgages in the second half of this year. So, two million mortgage holders will be paying about £6bn in additional interest payments next year. But that is only about 0.2 percent of GDP and not enough to ignite a recession.

The IFS reckons that this means that the disposable incomes of the average family will fall by a further four percent. Owner occupiers – normally an older demographic – will be entirely unaffected. There are about eight million households which have paid off their mortgages, as against about seven million households – one in three − which pay monthly mortgage payments. Some of the pain for the latter could be assuaged if lenders were to agree to extend the term of mortgage deals or offer interest-only deals in lieu.

That is why Jeremy Hunt is meeting with bank chiefs today to knock heads together. Mr Hunt will probably pressure the bosses of the biggest lenders to honour an agreement made with the Treasury and the Financial Conduct Authority last December under which banks are expected to provide tailored support to struggling customers. It is unlikely that anything substantive will come out of today’s meeting, but the political optics dictate that Mr Hunt must be seen to be doing something.

As usual, it pays to provide a little historical context to this “mortgage crisis”. In the short but sharp recession of the early 1990s under the government of Sir John Major, mortgage rates were running at around 13-14 percent. Many homeowners with mortgages struggled to make their payments, and repossessions were relatively common. But right now, there is no widespread negative-equity problem, repossessions are rare and house prices are barely lower than they were a year ago – despite woeful predictions to the contrary.

The main point is that the £6bn in additional mortgage-interest payments is money that will be sucked out of consumption in the economy, making recession more likely, though not certain. The economist and former MPC member Adam Posen thinks that recession is now “inevitable”, but as usual there is no consensus.

Hunt has resisted calls from Tory backbenchers to reintroduce mortgage-interest relief at source (MIRAS) to cushion the blow for mortgage payers. MIRAS was introduced in 1983 under Mrs Thatcher but was scrapped by Gordon Brown in April 2000. Mr Hunt thinks that the reintroduction of such a scheme would itself be inflationary. It would also be expensive.

What About The Renters?

According to the Daily Telegraph, most of the worst-affected mortgage holders reside in the Tories’ Blue Wall’ belt of parliamentary seats across the south of England – places like Jeremy Hunt’s constituency of South West Surrey. These voters might decide to punish the Conservatives in the forthcoming general election which I think will most likely take place in October of next year.

In British politics, traditionally, property owners tend to vote Tory while renters swing towards Labour. Mrs Thatcher sold off over one million council houses and – supposedly – many of those property owners became staunch Tories. But in recent years, home ownership has been on a downward trend as the young have been priced off the property ladder. The average house price was once three to four times the median annual wage: now it is more like nine times.

People who rent their accommodation are also feeling the pinch as buy-to-let landlords raise rents to cover rising mortgage interest bills – or, in many cases, sell up. People in their mid-30s to mid-40s are now three times more likely to rent accommodation than 20 years ago. In contrast, about 75 percent of the over 65s own their own home – and overwhelmingly vote Tory. Many in this demographic are also savers who welcome higher returns on their cash piles.

And yet, unfathomably, the Tory government has wilfully sought to weaken the buy-to-let housing sector on which an increasing number of households are dependent. They removed many of the reasonable tax incentives previously available to buy-to-let landlords (who are investors, since property investment for many is a form of pension provision). They determined that private landlords’ mortgage-interest payments and indeed many maintenance costs could not be deducted from rent for the calculation of their tax liability. And yet that does not apply to limited companies which buy and then let property.

Rents are now rising everywhere. In London, rents are up by 16 percent this year alone. Rents are now at their most unaffordable for a decade, according to Zoopla. The property portal found rents across the UK have been growing faster than earnings and now account for more than 28 percent of average pre-tax earnings.

It will be of little comfort to renters to reflect that the main reason they cannot afford to get onto the property ladder is that years of near-zero interest rates and money printing, initiated by the central bankers, has helped to push up property prices to historically exceptional levels.

Market Reaction

Further to the Bank of England’s announcement at noon on Thursday, UK gilt yields actually eased. That suggests the markets think the Bank is at last getting a grip on the slippery fish of persistent inflation. This morning the 10-year UK gilt is yielding 4.376 percent. The FTSE-100 was modestly down.

Looking out one to three years, the markets are now focussing on how a Labour government – now even more probable than previously – will manage the economy. The Sunak-Hunt strategy of Keep Calm and Carry On does not seem to be delivering electoral benefits. A fin de siècle mood prevails.