Hamish McRae: Enjoy the cheap money while it lasts

There is a troubling possibility that rising interest rates will choke off the recovery

Share
Related Topics

Interest rates are on the rise again. Not here as yet, nor in most of Europe or in the US. But looking around the world, it is clear that the tide of cheap money will turn in the next few months and the issue will be not where, whether or when, but how quickly rates will go up. And there will be little that an individual country such as our own will be able to do about it.

Actually something happened yesterday that highlights what will happen. Up to now there have been a few isolated cases of central banks increasing interest rates – Norway and Australia, for example – but there has been no general movement. But yesterday the Bank of China announced that it would increase the reserves that banks have to hold, the first such increase since June 2008. That is not a headline increase in rates as such but it is a sign of things to come.

China matters hugely. It is not only becoming the world's second-largest economy as it is now passing Japan, but it is also the world's largest source of savings. Its banks are the largest in the world: there is no talk of banks being "too big to fail" there. If you look at the world economy as a whole, as opposed to seeing it through a British, European or North American prism, the turning point in the interest rate cycle has now been reached.

In any case long-term interest rates are clearly on the rise and have been for some months. In Britain 10-year yields on government securities are over four per cent, whereas back last spring they were only about three per cent. Rates would doubtless have risen faster had it not been for the Bank of England buying so much of the Government's debt under its quantitative easing programme. That is now coming towards its end.

The Bank's Monetary Committee can decide to hold short-term interest rates down but it cannot control what happens to longer-term rates. These are determined by the supply and demand for savings around the world, and the UK Ggovernment has to compete for these savings, just like other would-be borrowers.

The effect of this is starting to be felt. It is more expensive now to get a fixed-rate mortgage than it was a few months ago. Companies seeking to reduce their bank loans by raising money with bond issues have to pay more for those funds. If there is any doubt about the security of a country's finances, its government finds it has to pay much more to cover its deficit. That is why Ireland and Greece have recently brought in severe budget measures, with clearly more to come in the case of Greece. It is why we too will have to get our public finances under control as soon as possible after the election.

But interest rates will rise irrespective of what our next government does – the question is one of degree – and we had better get used to this. Instinctively we know this. One of the really stunning things that has happened in recent months has been the extent to which British households have started to save again. You may recall that a couple of years ago people were actually spending more than they had in income: people borrowed against the value of their houses and used the money to hold up their consumption.

That has completely reversed, partly of course because mortgages have become much tighter. Now, savings are up to about eight per cent of income, the highest level since the early 1990s. People who are lucky enough to have mortgages linked to base rates seem to be using the extra monthly savings to pay back their mortgages more swiftly. The world has changed and we know it.

What we don't know is how quickly things get back to normal – for it is utterly abnormal to have base rates at 0.5 per cent or to deny savers any real return on their money – and what the consequences of higher interest rates will be. My own guess is that the first rise in UK interest rates will take place some time in the summer and that people will be surprised at the pace at which they subsequently climb. However that does depend on economic growth picking up through the second half of this year, not just here but everywhere else. It also depends on the financial credibility of the next government, for the less the credibility the faster rates are likely to rise.

That leads to the troubling possibility that rising interest rates will choke off the recovery. Even if the Bank of England manages to hold down short-term rates for a while, it cannot hold down long-term ones. And if the world is going to have more expensive money, we will too.

I come to three conclusions on this. The first is that any person or company that is likely to be relying on borrowing should be aware that the present era of cheap money will soon be over. So they should do their sums on the basis that they may have to pay more, maybe quite a lot more, for funds. There will be pressure on the banks to make money available but if the cost of the raw material goes up, so too will the price of the product. Thus at the moment we have the odd situation that loans are cheap but many people cannot get them, or at least cannot get as big a mortgage as they would like. That will end. Money will be available but it won't be cheap any more.

The second is that the present bounce in house prices is unlikely to be sustained because the conditions that have turned the market round, the flood of cheap money pumped into the economy, cannot be sustained. That is not to say that prices will plunge back to the trough they reached a few months ago; just that we are likely to have several years of pretty stagnant prices as our incomes gradually catch up with a price level that is still high by the standards of the past 40 years.

The third is that we are no longer masters of our own fate. Yes, we have a committee at the Bank of England that sets short-term interest rates. Yes, we have a Government that determines tax and spending levels. But the freedom that both have experienced to set policy over the past 12 years will be much more limited for the foreseeable future. Trust has gone; power has shifted. If some time in the coming months the Chinese start increasing interest rates sharply, expect us to have to follow.

h.mcrae@independent.co.uk

React Now

Latest stories from i100
Have you tried new the Independent Digital Edition apps?
SPONSORED FEATURES
iJobs Job Widget
iJobs General

Recruitment Genius: Sales Negotiator - OTE £23,000

£13500 - £23000 per annum: Recruitment Genius: This award winning, Bolton base...

Recruitment Genius: Client Account Executive

£23000 - £30000 per annum: Recruitment Genius: A Client Account Executive is r...

Recruitment Genius: Telemarketing Executive

£7 per hour: Recruitment Genius: Full Time position available now at a growing...

SThree: Trainee Recruitment Consultant

£20000 - £25000 per annum + competitive + incentives + uncapped comms: SThree:...

Day In a Page

Read Next
 

Daily catch-up: the SNP’s ‘fundamental problem’, says Corbyn, is that too many people support it

John Rentoul
An investor looks at an electronic board showing stock information at a brokerage house in Shanghai  

China has exposed the fatal flaws in our liberal economic order

Ann Pettifor
The Silk Roads that trace civilisation: Long before the West rose to power, Asian pathways were connecting peoples and places

The Silk Roads that trace civilisation

Long before the West rose to power, Asian pathways were connecting peoples and places
House of Lords: Outcry as donors, fixers and MPs caught up in expenses scandal are ennobled

The honours that shame Britain

Outcry as donors, fixers and MPs caught up in expenses scandal are ennobled
When it comes to street harassment, we need to talk about race

'When it comes to street harassment, we need to talk about race'

Why are black men living the stereotypes and why are we letting them get away with it?
International Tap Festival: Forget Fred Astaire and Ginger Rogers - this dancing is improvised, spontaneous and rhythmic

International Tap Festival comes to the UK

Forget Fred Astaire and Ginger Rogers - this dancing is improvised, spontaneous and rhythmic
War with Isis: Is Turkey's buffer zone in Syria a matter of self-defence – or just anti-Kurd?

Turkey's buffer zone in Syria: self-defence – or just anti-Kurd?

Ankara accused of exacerbating racial division by allowing Turkmen minority to cross the border
Doris Lessing: Acclaimed novelist was kept under MI5 observation for 18 years, newly released papers show

'A subversive brothel keeper and Communist'

Acclaimed novelist Doris Lessing was kept under MI5 observation for 18 years, newly released papers show
Big Blue Live: BBC's Springwatch offshoot swaps back gardens for California's Monterey Bay

BBC heads to the Californian coast

The Big Blue Live crew is preparing for the first of three episodes on Sunday night, filming from boats, planes and an aquarium studio
Austin Bidwell: The Victorian fraudster who shook the Bank of England with the most daring forgery the world had known

Victorian fraudster who shook the Bank of England

Conman Austin Bidwell. was a heartless cad who carried out the most daring forgery the world had known
Car hacking scandal: Security designed to stop thieves hot-wiring almost every modern motor has been cracked

Car hacking scandal

Security designed to stop thieves hot-wiring almost every modern motor has been cracked
10 best placemats

Take your seat: 10 best placemats

Protect your table and dine in style with a bold new accessory
Ashes 2015: Alastair Cook not the only one to be caught in The Oval mindwarp

Cook not the only one to be caught in The Oval mindwarp

Aussie skipper Michael Clarke was lured into believing that what we witnessed at Edgbaston and Trent Bridge would continue in London, says Kevin Garside
Can Rafael Benitez get the best out of Gareth Bale at Real Madrid?

Can Benitez get the best out of Bale?

Back at the club he watched as a boy, the pressure is on Benitez to find a winning blend from Real's multiple talents. As La Liga begins, Pete Jenson asks if it will be enough to stop Barcelona
Athletics World Championships 2015: Beijing witnesses new stage in the Jessica Ennis-Hill and Katarina Johnson-Thompson heptathlon rivalry

Beijing witnesses new stage in the Jess and Kat rivalry

The last time the two British heptathletes competed, Ennis-Hill was on the way to Olympic gold and Johnson-Thompson was just a promising teenager. But a lot has happened in the following three years
Jeremy Corbyn: Joining a shrewd operator desperate for power as he visits the North East

Jeremy Corbyn interview: A shrewd operator desperate for power

His radical anti-austerity agenda has caught the imagination of the left and politically disaffected and set a staid Labour leadership election alight
Isis executes Palmyra antiquities chief: Defender of ancient city's past was killed for protecting its future

Isis executes Palmyra antiquities chief

Robert Fisk on the defender of the ancient city's past who was killed for protecting its future