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SPECIAL FEATURE: Carney vs the Consumer

Robyn Hall

August 19, 2013

So, as we saw on August 7th, the Bank of England’s Monetary Policy Committee under new chairman Mark Carney, hopes to stimulate consumer and business spending by committing to maintain the current low base rate for the next three years. It’s also clear that the Government hopes that in conjunction with the Fund for Lending, Help to Buy and other mortgage related schemes in the pipeline for next year, Carney’s forward guidance will be a shot in the arm for the housing market. Will any of it work? And if it does, will it be without negative, unintended consequence?

Will forward guidance get businesses investing?

On the business side, doubts arise from the recent shift of concern from banks being unwilling to lend to businesses, to businesses being unwilling to borrow for investment purposes. This has been attributed to the levels of excess capacity already in their industries and the lack of sufficiently compelling economic data to make them believe that increased demand will materialise in the near future to soak up that excess. Hence those businesses that are solvent are sitting on their cash balances rather than spending them. Meanwhile at the other end of the spectrum, lies a mass of hopelessly insolvent firms that can barely service their debts, even at these historically low interest rate levels. Simulating consumer spending is hoped to be an effective catalyst for unlocking this stalemate.

Will forward guidance loosen consumer purse strings?

Again, a lot of interlinking factors influence consumers’ propensities to borrow and spend. For example, how much discretionary income do they actually have? Is this new predictability in interest rates (if they understand it) going to be enough to make them willing to spend any of that discretionary income on goods and services rather than saving it or using it to paying down existing debts in anticipation of the eventual higher interest rates. Indeed, for how many consumers who are not already maxed out on their available credit, will this be enough to make them take on new debts for the purposes of consumption? For how many will this be enough to take on a new mortgage commitment?

There are a couple of pieces of research floating around that paint a picture of the factors that will be informing these decisions on an individual level.

Firstly, an attempt by the Daily Telegraph and Zoopla to quantify the role of interest rates in the decision whether to buy a home or rent.

And secondly a report from the Bank of England looking at how many people are vulnerable to the rate rises that we can reasonably expect in a few years time. In particular what would be the impact of rates normalising? (ie. returning to levels that match inflation to compensate savers for the erosion of the real value of their cash by rising prices.)

To buy or not to buy?

Back in June the Daily Telegraph asked Zoopla to crunch some numbers to quantify the impact on homeowners of the rate rises that will eventually come. The question they asked was this: “How much would mortgage interest rates have to rise before it would become cheaper for the average homeowner, to rent a comparable property than to maintain their mortgage payments?”

Worryingly, Zoopla’s estimate was that the average mortgage rates paid by Britons would have to rise only by 0.69%, taking the cost up by £80 to £668 a month for it to be cheaper to rent a comparable property than to buy – and that’s nationwide. That’s not to suggest that many people owning their own home would sell up and choose to rent instead, but it does give us an indication of the sort of comparisons that many potential homebuyers must be making.

In a market where future house price rises are not the “sure thing” they were, paying rent may not be viewed quite so much as dead money by the most logical consumers.

However we Brits love to own our own homes so the emotional call will be stronger for many.

Add to that the signs that the Fund for Lending and Help to Buy schemes are already reinflating the property bubble and those would-be homeowners are going to be reading increasingly frequent reports of rising property prices and suddenly feel they will lose out if they wait.

All of these factors will conspire to lead many to enter the market, (or upsize), at price levels that have not fully corrected since the last boom, because interest rates have been kept artificially low for so long.

Sadly, many of those new entrants to the market will be extending themselves to the limit and could be setting themselves up for a serious fall.

In a report from earlier in this year of 2013 P.C. (pre-Carney), the Bank of England forecast that millions of households would be plunged into crisis by even a small interest rate rise.

Just setting a longer countdown on the timebomb?

According to the Bank of England model, even if rates were increased by only 1% to 1.5%, around 9% of people with mortgages would need to find extra cash from somewhere.

That report also suggested that if rates rose by 2%, as required to bring them almost into line with inflation, even though not yet high enough to yield a real return on savings, the consequence would be that one in five households would have to either cut essential spending or work longer hours.

The hypothetical 2% rate rise referred to would result in monthly repayments on an average £160,000 mortgage going up by nearly £2,200 a year.

With those risks still clearly visible on the road ahead, just a little further away, it seems likely that it won’t be the informed and prudent consumers who stop deleveraging and take on the long term commitment of a new or bigger mortgage. It won’t be the solvent homeowner who dusts off the credit card and starts spending again just because the prospect of rate increases has receded by a few years. Rather it will be those very people for whom the inevitable eventual rate rise will probably be enough to put them under.

Tick, tick, tick, tick….


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