Yesterday morning, I speculated about the dangers associated with AI. Today, I’m going for a challenge much closer to home (pun intended): rising mortgage rates. Two-year fixed mortgages have reached 6 per cent; five year-fixed rates have reached 5.7 per cent. The explanation for this is simple: market expectations of another interest rate rise due to yesterday’s worse-than-expected inflation figures.
As David Willetts highlighted for us earlier this week, this is of huge concern to the more than 2.4 million homeowners whose mortgages need renewing between today and the end of 2024. The Resolution Foundation suggests the average cost of a mortgage will go up by almost £3,000 for the 800,000 people re-mortgaging next year.
This is of obvious concern to a Rishi Sunak government which must hold an election by January 2025. With young people (hello!) largely priced out of the market and many older voters owning their homes out-right, there is a sense in which those squeezed by rising rates are those Margaret Thatcher would have called “our people”: relatively affluent, upwardly mobile, housing market aspirationalists.
It also matters to Sunak for the simple reason that halving inflation is one of the five pledges on which he has staked his government’s credibility. That controlling inflation is supposed to be the job of Andrew Bailey didn’t stop Number 10 from spotting the consensus that inflation was supposed to plummet his summer and deciding to pluck at some low-hanging fruit.
Unfortunately, that tactical footwork has come a cropper now that inflation has stuck at 8.7 per cent – against expectations of a 0.3 per cent fall – for the last two months. As such, Bailey and co are expected to raise interest rates by 0.25 per cent to 4.75 per cent on Thursday – or further. Hence why the number of mortgage deals on offer has plummeted by almost 150 since last summer.
Why is inflation proving so stubborn? The initial bout of inflation we have endured since 2020 stemmed from the combination of the Bank of England printing more money during the pandemic than in the previous decade, the supply-side shocks caused by the closing and then re-opening of the global economy due to lockdowns, and the subsequent energy shock triggered by the Ukraine war.
Yet all these proximate causes have started to wear off. Monetarists have started to warn that the rate of tightening – the rate of hikes in the US, for example, is faster than at any time in recent history – is excessive. Lockdowns have long-term consequences, but supply changes have had time to readjust. Energy prices are falling rapidly, and food inflation appears to have peaked.
So why is core inflation at its highest rate in 31 years (7.1 per cent) and rising? Core inflation, as a reminder, is the set of figures that removes volatile factors such as energy and food prices, to simplify the outlook. The UK is increasingly an outlier in it accelerating. Rates in the US and Germany are falling, whilst only Argentina, Brazil, Mexico, and Turkey out pace us in the G20.
Various kooky suggestions have been given for explaining rises, including the sale of Beyonce concert tickets and the popularity of the new Zelda game. But it would appear the most basic reason is the UK’s tight labour market and the consequence of this for services and their prices. We have very low unemployment, and over a million vacancies. This has driven a sharp rise in the rate of pay growth.
Simply put, businesses have aimed to retain their workers by offering high wage increases. Earnings were up 7.2 per cent on the year to April – a record rise. Meanwhile, service prices were up 7.4 per cent on the year. We seem to be staring down the barrel at the same problem we encountered in the 1970s: inflationary expectations are becoming embedded, with wages and prices trapped in a loop.
In the absence of any serious supply-side agenda able to get past Conservative MPs, the Prime Minister has few tools at his disposal to reduce inflation, and thus interest rates, except plead nicely with the supermarkets and cross his fingers. His Chancellor and his allies have been more honest as to what is required: a recession, as Jeremy Hunt admitted last month.
As Karen Ward, a member of his advisory council, has put it, the Bank of England – deprived as its Monetary Policy Committee is of any monetarists – “has been too hesitant” when it comes to interest rate rises. It might be painful, but it isn’t painful enough: companies and workers don’t yet feel sufficiently nervous about the future. Bailey therefore has no choice but to “create a recession”.
Of course, such a proposition on the eve of an election year is something that no Prime Minister wants to hear. Nor will it have much appeal for those seeing their mortgages surge. Already, Hunt has had to fend off calls for a mortgage relief scheme – modelled on that designed to protect household energy bills – from MPs worried about losing their seats (as if they had much else going for them otherwise).
Willetts suggested a few potential options for the Government if intervention is required. Subsidising bills is a non-starter. Future generations will be expected to pay higher taxes to help those lucky enough to be on the housing ladder today – and the last thing Sunak and Hunt want to be doing is putting further pressure on gilt yields.
Encouraging a move towards longer-term fixed rate mortgages would be sensible, but lenders would unlikely be keen without the form of handout that America manages via Fannie Mae and Fannie Mac. An expansion of the Support for Mortgage Interest scheme designed to aid homeowners at particular risk might avoid the appearance of a government subsidising the rates of the affluent.
Yet any subsidy program that blunts the pain of rate rises too much is self-defeating. In the words of John Major, “if the policy isn’t hurting, it isn’t working”. We need unemployment to be rising, businesses to go bust, and homes to repossessed. It is hardly the news any politician wants to hear on the eve of an election year.
But as Major himself discovered, the voters can forgive you for taking them into a recession if they think you’re also the right person to take them out of it. It’s hard medicine. But we cannot plan for any form of economic recovery until the cancer of inflation is wrung out of the system. Chemotherapy is hardly famous for being pleasant.
Bailey is far too dove-ish to embrace such a route, so here’s my 569th call for the Governor to be sacked. This strategy is hardly likely to be warmly embraced in Downing Street, whatever the Chancellor’s harsh language. Whilst it might help Sunak towards his pledge on inflation, it is rather unhelpful for his ambition to get the economy growing or to reduce debt.
Which means a hard choice must be faced. Sunak needs to bite the bullet and get ready to junk his inflation pledge if the numbers do not improve. Sacking Bailey would be useful sign that he takes the mission seriously, even if it skates a little too close to last year’s chaos. But there is no point in denying reality. A bitter pill needs swallowing.