The euro paradox is choking our economy


A small paradox: the UK economy avoided the formal recession feared earlier this year and is now picking up speed rapidly - heading to 3 per cent GDP growth next year. So the Bank of England raised short-term rates to 5.5 per cent.

However, euroland's economy also slowed down during the first half - to only 1.6 per cent GDP growth. But it is now accelerating vigorously towards a 3.5 per cent growth rate in mid-2000. So the European Central Bank raised its rates - but only to 3 per cent.

This discrepancy may be particularly galling to UK home-owners. It is widely argued that the UK economy is far more sensitive to short- term interest rates because the vast majority of consumer debt is held in the form of floating-rate mortgages. The Bank of England remains fearful that rising houses prices will feed through into inflation because the precedent of the 1980s is still fresh in the mind.

But would this sensitivity persist if the UK were to join EMU? Even the Bank's own researchers have concluded that such a change would make past relationships invalid. So a big discrepancy in interest rates might be unnecessary in the future if the structure of the British economy moved towards that of euroland.

A lengthy period of interest rates that seem low to UK home-owners could impact on the form of housing finance, encouraging a move towards Continental- style, fixed-rate mortgages. But this requires long-term British interest rates to be low enough to stimulate a demand for mortgages fixed for, say, 15 years or even longer.

That would swing attention to the big paradox: the rate for 30-year bonds, not for short-term deposits. Little attention is given to this arcane subject but those who play in this market are not taking a bet for the next three months, they are playing for the remainder of a lifetime.

Many people approaching retirement are forced by government regulations to buy an annuity with the proceeds of their personal or money-purchase pension schemes. The rate offered for this annuity hinges on the interest rates that the government of the day pays on its long- term bonds.

During 1999, these rates have fallen to amazingly low levels - 4.2 per cent today. The current pattern of interest rates implies that, in a decade, 10-year rates will be around 3 per cent. Recently, these "forward" rates even fell to about 2.5 per cent - the lowest level this century. Annuity rates could ratchet down even further in the years ahead. Moreover, the returns on endowment insurance policies could also decline again, to the even greater discomfort of those relying on such policies to repay their mortgages.

Would-be annuitants are engaged in a battle with their friends in "final salary" pension schemes. Both are required to invest in safe assets, and the bonds issued by the Government itself are ideal in a world of low inflation. But the Government's finances are increasingly healthy so it needs to issue very few long-term bonds: good news for "sound money" but bad news for these savers.

The combination of an ageing population and government regulation is swelling the cash available to pension and life funds. As these two groups have already bought up nearly all the Government's long bonds, they are competing with each other to snap up any new ones, so sending prices spiralling. Correspondingly, this shrinks the returns available to new annuitants and boosts the costs of final-salary schemes to employers.

These distortions in Britain's financial system seem extraordinary when viewed from across the Channel in euroland. Corresponding German government bonds yield 5.6 per cent - nearly a third more than in Britain.

Continental yields may be enticingly higher but they are in a different currency. Sterling has appreciated dramatically against the European currencies over the last three years and the consequences are now showing up in a bulging current account deficit, leading many commentators to believe sterling to be substantially overvalued.

If Britain's attitude to joining the euro was clear - thereby removing that currency risk - then those high yields could flow to British pensioners. Interestingly, the corresponding currency outflow could force sterling down to a more realistic level. If extra competition in the UK market obliges companies to absorb the resulting surge in import prices, rather than passing them on to consumers via inflation, then investors could get a double benefit.

n Graham Bishop is adviser, European financial affairs, for Salomon Smith Barney/Citigroup.

people'It can last and it's terrifying'
Danny Welbeck's Manchester United future is in doubt
footballGunners confirm signing from Manchester United
footballStriker has moved on loan for the remainder of the season
footballFeaturing Bart Simpson
New Articles
Olivia Colman topped the list of the 30 most influential females in broadcasting
Kelly Brook
peopleA spokesperson said the support group was 'extremely disappointed'
The five geckos were launched into space to find out about the effects of weightlessness on the creatures’ sex lives
Life and Style
techIf those brochure kitchens look a little too perfect to be true, well, that’s probably because they are
Andy Murray celebrates a shot while playing Jo-Wilfried Tsonga
TennisWin sets up blockbuster US Open quarter-final against Djokovic
Arts and Entertainment
Hare’s a riddle: Kit Williams with the treasure linked to Masquerade
booksRiddling trilogy could net you $3m
Arts and Entertainment
Alex Kapranos of Franz Ferdinand performs live
music Pro-independence show to take place four days before vote
ebooksAn unforgettable anthology of contemporary reportage
news Video - hailed as 'most original' since Benedict Cumberbatch's
Life and Style
The longer David Sedaris had his Fitbit, the further afield his walks took him through the West Sussex countryside
lifeDavid Sedaris: What I learnt from my fitness tracker about the world
Arts and Entertainment
Word master: Self holds up a copy of his novel ‘Umbrella’
booksUnlike 'talented mediocrity' George Orwell, you must approach this writer dictionary in hand
Latest stories from i100
Have you tried new the Independent Digital Edition apps?
Independent Dating

By clicking 'Search' you
are agreeing to our
Terms of Use.

iJobs Job Widget
iJobs Money & Business

SQL Implementation Consultant (VB,C#, SQL, Java, Eclipse, integ

£40000 - £50000 per annum + benefits+bonus+package: Harrington Starr: SQL Impl...

Head of IT (Windows, Server, VMware, SAN, Fidessa, Equities)

£85000 per annum: Harrington Starr: Head of IT (Windows, Server, VMware, SAN, ...

Technical Software Consultant (Excel, VBA, SQL, JAVA, Oracle)

£40000 - £50000 per annum: Harrington Starr: You will not be expected to hav...

SQL DBA/Developer

£500 per day: Harrington Starr: SQL DBA/Developer SQL, C#, VBA, Data Warehousi...

Day In a Page

'I’ll tell you what I would not serve - lamb and potatoes': US ambassador hits out at stodgy British food served at diplomatic dinners

'I’ll tell you what I would not serve - lamb and potatoes'

US ambassador hits out at stodgy British food
Radio Times female powerlist: A 'revolution' in TV gender roles

A 'revolution' in TV gender roles

Inside the Radio Times female powerlist
Endgame: James Frey's literary treasure hunt

James Frey's literary treasure hunt

Riddling trilogy could net you $3m
Fitbit: Because the tingle feels so good

Fitbit: Because the tingle feels so good

What David Sedaris learnt about the world from his fitness tracker
Saudis risk new Muslim division with proposal to move Mohamed’s tomb

Saudis risk new Muslim division with proposal to move Mohamed’s tomb

Second-holiest site in Islam attracts millions of pilgrims each year
Alexander Fury: The designer names to look for at fashion week this season

The big names to look for this fashion week

This week, designers begin to show their spring 2015 collections in New York
Will Self: 'I like Orwell's writing as much as the next talented mediocrity'

'I like Orwell's writing as much as the next talented mediocrity'

Will Self takes aim at Orwell's rules for writing plain English
Meet Afghanistan's middle-class paint-ballers

Meet Afghanistan's middle-class paint-ballers

Toy guns proving a popular diversion in a country flooded with the real thing
Al Pacino wows Venice

Al Pacino wows Venice

Ham among the brilliance as actor premieres two films at festival
Neil Lawson Baker interview: ‘I’ve gained so much from art. It’s only right to give something back’.

Neil Lawson Baker interview

‘I’ve gained so much from art. It’s only right to give something back’.
The other Mugabe who is lining up for the Zimbabwean presidency

The other Mugabe who is lining up for the Zimbabwean presidency

Wife of President Robert Mugabe appears to have her sights set on succeeding her husband
The model of a gadget launch: Cultivate an atmosphere of mystery and excitement to sell stuff people didn't realise they needed

The model for a gadget launch

Cultivate an atmosphere of mystery and excitement to sell stuff people didn't realise they needed
Alice Roberts: She's done pretty well, for a boffin without a beard

She's done pretty well, for a boffin without a beard

Alice Roberts talks about her new book on evolution - and why her early TV work drew flak from (mostly male) colleagues
Get well soon, Joan Rivers - an inspiration, whether she likes it or not

Get well soon, Joan Rivers

She is awful. But she's also wonderful, not in spite of but because of the fact she's forever saying appalling things, argues Ellen E Jones
Doctor Who Into the Dalek review: A classic sci-fi adventure with all the spectacle of a blockbuster

A fresh take on an old foe

Doctor Who Into the Dalek more than compensated for last week's nonsensical offering