As it happens, I briefly met the Governor of the Bank of England recently. Yes, Mark Carney himself, in the flesh.
And I had meant to tell him an important story about interest rates and how they influence the property market, but never got the chance. So, I’ll tell it here – it’s worth hearing and I’m sure he is an avid reader of this blog.
Way back in 2004, the Bank of England was very gradually pushing base rates higher. Rates rose from 3.5% to 4.5% between July 2013 and June 2014. The then Governor, Mervyn King, visited Glasgow in June and gave a speech to the CBI.
In it, he said “Anyone entering or moving within the housing market should consider carefully the possible future paths of both house prices and interest rates”.
The next day, the telephones in estate agencies across Glasgow fell silent. One agent assumed there was a fault with its telephones and complained to BT. The truth was that the governor’s widely reported comments had had an immediate impact on the property market and buyer intentions without the Bank having to change rates at all.
The story is important because it illustrates the enormous influence the Governor of the Bank of England can have even without any change in rates.
Fast forward to this year and another Governor of the Bank, Mark Carney, is back in Glasgow giving a speech that, among other things, confirms that any increase in interest rates will be ‘gradual and limited’ You can see the speech here.
But I wonder whether that message has really got through.
The point is that Governor Carney really means what he says about interest rates. In the same speech, he points out that: ‘History shows that the British people do everything they can to pay their mortgages. That means cutting back deeply on expenditures when the unexpected happens.’
In other words, the Bank knows that a significant increase in interest rates (and so mortgage costs) would have a disproportionate effect on consumer demand which, in turn, could damage the speed and scale of the recovery. To put that in context, a recent report from Verum Financial Research suggested that for every 0.5% increase in base rate will cut £4.8bn from householdspending.
And that is exactly why the Bank will be so cautious about increasing rates. That is even more true because wage growth has been so slow. Without an increase in real wages, any increase in debt costs will come straight out of consumer spending, reducing growth at a time when the economy remains fragile.
The latest inflation report from the Bank (you can find it here) suggests that the markets think rates will ultimately peak at 2.25% – and only then after several years. That’s less than half the long term average.
Much of the commentary in the media assumes that – when rates do start to rise again – the Bank will choose to do so in increments of 0.25%. For what it’s worth (which is not much, I admit), I suspect that the Bank will increase the base rate by 0.15% at a time. Even then, it might allow a considerable gap between one increase and the next.
Finally, I suspect that the real trigger for an increase in rates will be rising real wages. Wage increases are important because they have the potential to drive inflation (if not matched by improvements in productivity). But they also give the indebted consumer a chance to cover higher repayments. In other words, rates are likely to rise at exactly the point at which we feel we can afford it.
So, if you are worried about increases in interest rates, read his [Mark Carney’s] lips – he really means it when he says any changes will be gradual and limited.