tag:theconversation.com,2011:/ca/topics/bank-of-england-3332/articlesBank of England – The Conversation2024-01-22T10:57:00Ztag:theconversation.com,2011:article/2204442024-01-22T10:57:00Z2024-01-22T10:57:00ZInflation: how a different approach could ease the burden of the cost of living crisis<figure><img src="https://images.theconversation.com/files/570024/original/file-20240118-29-c6xyx6.jpg?ixlib=rb-1.1.0&rect=89%2C145%2C7398%2C4839&q=45&auto=format&w=496&fit=clip" /><figcaption><span class="caption">
</span> <span class="attribution"><a class="source" href="https://www.shutterstock.com/image-photo/rising-arrow-against-uk-flag-power-2198595815">Viktollio/Shutterstock</a></span></figcaption></figure><p>The latest annual inflation rate <a href="https://www.ons.gov.uk/economy/inflationandpriceindices/bulletins/consumerpriceinflation/december2023">rise to 4%</a> has <a href="https://www.ft.com/content/42c4bece-abd9-4e02-a403-66f1a29647b4">dampened expectations</a> about how soon the Bank of England might start cutting interest rates. Marginally higher than the previous month’s figure of 3.9%, it was <a href="https://www.ft.com/content/42c4bece-abd9-4e02-a403-66f1a29647b4">a surprise</a> to some economists. </p>
<p>This adds to the economic uncertainty which may make the Bank move cautiously. The impact of the war in the Middle East, and Houthi <a href="https://theconversation.com/red-sea-crisis-suez-canal-is-not-the-only-choke-point-that-threatens-to-disrupt-global-supply-chains-221144">attacks in the Red Sea</a> on shipping on transport costs and supply chains remains unclear, for example. And then there is the decrease in UK job vacancies and the <a href="https://www.theguardian.com/business/2023/dec/12/uk-pay-growth-job-vacancies-interest-rates">slowdown in wage increases</a> to consider before interest rates start heading downwards.</p>
<p>But perhaps the Bank’s apparent focus on cooling down the economy via high interest rates is the wrong way to tackle inflation. Our work looks at a <a href="https://peri.umass.edu/images/Onaran-PERI-Inflation-Conf-WP.pdf">different approach</a> which would use a much <a href="https://academic.oup.com/cje/article-abstract/47/4/703/7237926?redirectedFrom=fulltext&login=false">wider range of considerations</a> including investment, industrial priorities, labour market policy and tax rates. </p>
<p>We describe it as a “needs-based” approach to inflation and government policy, because it is designed to address specific social, environmental and economic requirements. It means asking questions about things such as how much investment we need in renewable energy, public transport and housing to achieve a zero-carbon economy by 2050? Or how many care workers will help meet changing demographic trends – and what is a decent rate of pay for the valuable work they do? </p>
<p>Identifying these needs, and the right level of investment to satisfy them, also requires a different approach to politics more generally – because it demands a concerted effort towards learning what the UK population needs. It means directly <a href="https://citizensecon.org.uk/">engaging with citizens</a> (through regional assemblies or surveys for example) and using their knowledge and experience to inform decisions. This information can then be used to formulate policies both fiscal (by the governement) and monetary (by the Bank of England). </p>
<p>It sounds like a simple and obvious idea – finding out what people actually need, and then developing policies which might help them. But the government’s current fiscal targets – lower borrowing, lower debt, a cap on welfare spending – and the Bank of England’s strategy of aiming for an <a href="https://www.bankofengland.co.uk/monetary-policy/inflation">inflation rate of 2%</a> are far removed from these goals. </p>
<p>Instead, they are blunt tools which are failing to tackle multiple crises. But if fiscal policy was tied to a major public investment programme, <a href="https://academic.oup.com/cje/article-abstract/47/4/703/7237926?redirectedFrom=fulltext&login=false">research suggests</a> it could help to tackle major issues such as social care, health, education, food, energy and climate change. </p>
<p>For this approach to work, the Bank of England <a href="https://committees.parliament.uk/writtenevidence/23107/html/">needs to adjust to an inflation target</a> that moves within a band of around 4%-5%. But it also needs to be involved with an area outside its current remit – achieving a full (or very high) rate of employment, which brings clear <a href="https://academic.oup.com/cje/article-abstract/47/4/703/7237926?redirectedFrom=fulltext&login=false">economic benefits</a> such as increased productivity and greater tax revenue. </p>
<figure class="align-center ">
<img alt="Wind turbines in rural setting." src="https://images.theconversation.com/files/570095/original/file-20240118-22-old0n0.jpg?ixlib=rb-1.1.0&q=45&auto=format&w=754&fit=clip" srcset="https://images.theconversation.com/files/570095/original/file-20240118-22-old0n0.jpg?ixlib=rb-1.1.0&q=45&auto=format&w=600&h=352&fit=crop&dpr=1 600w, https://images.theconversation.com/files/570095/original/file-20240118-22-old0n0.jpg?ixlib=rb-1.1.0&q=30&auto=format&w=600&h=352&fit=crop&dpr=2 1200w, https://images.theconversation.com/files/570095/original/file-20240118-22-old0n0.jpg?ixlib=rb-1.1.0&q=15&auto=format&w=600&h=352&fit=crop&dpr=3 1800w, https://images.theconversation.com/files/570095/original/file-20240118-22-old0n0.jpg?ixlib=rb-1.1.0&q=45&auto=format&w=754&h=442&fit=crop&dpr=1 754w, https://images.theconversation.com/files/570095/original/file-20240118-22-old0n0.jpg?ixlib=rb-1.1.0&q=30&auto=format&w=754&h=442&fit=crop&dpr=2 1508w, https://images.theconversation.com/files/570095/original/file-20240118-22-old0n0.jpg?ixlib=rb-1.1.0&q=15&auto=format&w=754&h=442&fit=crop&dpr=3 2262w" sizes="(min-width: 1466px) 754px, (max-width: 599px) 100vw, (min-width: 600px) 600px, 237px">
<figcaption>
<span class="caption">Green investment opportunities.</span>
<span class="attribution"><a class="source" href="https://www.shutterstock.com/image-photo/concept-idea-eco-power-energy-wind-1040226574">lovelyday12/Shutterstock</a></span>
</figcaption>
</figure>
<p>Central banks can influence employment rates by using the money supply to maintain stable prices as well as supporting public and private investment that leads to job creation. Targeting employment as well as inflation would require monetary policy to take into account public investment plans, as well as <a href="https://academic.oup.com/cje/article-abstract/47/4/703/7237926?redirectedFrom=fulltext&login=false">higher taxes on income and wealth</a> to fund it. </p>
<h2>Inflating inflation for the general good</h2>
<p>And given the high levels of required investment in both the green and the care economies, monetary policy needs to be more “expansionary”. This effectively means lower interest rates and increasing the money supply, which would lead to inflation rates being higher than 2%. </p>
<p>After all, the current 2% inflation target and recent interest rate hikes have <a href="https://www.ons.gov.uk/economy/grossdomesticproductgdp/bulletins/quarterlynationalaccounts/julytoseptember2023">not been good for the UK economy</a>. And while many people might be alarmed at the idea of an inflation target of 4%-5%, the impact would actually have benefits. </p>
<p>A more vibrant economy with new investment in social housing, renewable energy, public transport, health care, childcare, education, decent jobs <a href="https://www.researchgate.net/publication/345412570_The_effects_of_income_distribution_and_fiscal_policy_on_aggregate_demand_investment_and_the_budget_balance_the_case_of_Europe1">and pay rises could reverse</a> the decades-long squeeze on real wages.</p>
<p>To absorb the effects of potential temporary cost shocks cause by higher inflation, <a href="https://peri.umass.edu/images/Onaran-PERI-Inflation-Conf-WP.pdf">some economists</a>) suggest using price controls in <a href="https://scholarworks.umass.edu/econ_workingpaper/340/">vital sectors</a> such as energy, housing, food and transportation.</p>
<p>Meanwhile, the Bank of England’s determination to reach 2% inflation target has cost millions of households dear. And it does not seem to be consistent with sound economic planning. Raising it to a band around 4%-5% would allow for urgent and large scale public investment – and an end to the cost of living crisis.</p><img src="https://counter.theconversation.com/content/220444/count.gif" alt="The Conversation" width="1" height="1" />
<p class="fine-print"><em><span>Özlem Onaran received funding from ESRC Rebuilding Macroeconomics, International Trade Union Confederation, Women’s Budget Group, American University, the Institute for New Economic Thinking, the Foundation of European Progressive Studies, the Vienna Chamber of Labour, and Unions21.</span></em></p>We should not be afraid of inflation being higher than 2%.Özlem Onaran, Professor of Economics, University of GreenwichLicensed as Creative Commons – attribution, no derivatives.tag:theconversation.com,2011:article/2198582024-01-05T16:14:55Z2024-01-05T16:14:55ZConsumer confidence is rising amid gloomy economic news – here’s what that means and why it matters<figure><img src="https://images.theconversation.com/files/567594/original/file-20240102-27-kfpc1i.jpg?ixlib=rb-1.1.0&rect=23%2C39%2C5268%2C3464&q=45&auto=format&w=496&fit=clip" /><figcaption><span class="caption">
</span> <span class="attribution"><a class="source" href="https://www.shutterstock.com/image-photo/busy-city-street-people-on-zebra-182220608">Photomika-com/Shutterstock</a></span></figcaption></figure><p>People’s confidence in the UK’s economic outlook <a href="https://www.gfk.com/press/nov-uk-consumer-confidence-stages-end-of-year-rally">improved</a> towards the end of 2023, despite continuing to battle a cost-of-living crisis. Although it has strengthened over the year to December, “consumer sentiment” as this confidence is called, is still <a href="https://www.gfk.com/press/christmas-cheer-sees-december-headline-score-up-two-points-at-22">in negative territory</a>.</p>
<p>Indeed, UK consumer price inflation remains well above the Bank of England’s 2% target and interest rates are at highs not seen since the wake of the global financial crisis in 2008?. And, of course, the outlook for the UK economy in 2024 is also <a href="https://www.theguardian.com/business/live/2023/dec/19/uk-economy-at-risk-of-hard-landing-warning-ftse-pound-eurozone-inflation-pimco">in the doldrums</a>.</p>
<p>British economist John Maynard Keynes talked about <a href="https://www.economicshelp.org/animal-spirits/">“animal spirits”</a> meaning the psychological factors that drive firm’s investment decisions. But economists also take people’s feelings into account when making predictions about the direction of the economy. So, with consumer confidence rising in spite of all of these negative indicators, what role does this kind of optimism play in economic forecasts?</p>
<p>Traditionally, when trying to gauge the country’s financial prospects, economists focused on households’ ability to consume, <a href="http://dx.doi.org/10.1111/j.1467-9957.2012.02333.x">arguing that</a> expectations of <a href="http://dx.doi.org/10.1016/j.jmacro.2004.03.001">future household income</a> are a crucial determinant of people’s current consumption. For instance, you’ll be more reluctant to splash out now if you think inflation is going to sky-rocket next year, squeezing your finances in the future. </p>
<p>But willingness to consume is also increasingly important to economists, especially during difficult times. Such “consumer sentiments” describe the psychological state of households, or people, rather than the present reality of their personal finances. When economists know people are optimistic about the economy, they assume they are more willing to spend or consume more and, if not, they are expected to save more instead.</p>
<p>In the US, consumer sentiment is tracked by the University of Michigan’s <a href="https://data.sca.isr.umich.edu/">Surveys of Consumers</a>, which is based on a monthly poll of a sample of households. UK consumer sentiment is represented by the <a href="https://www.gfk.com/products/gfk-consumer-confidence-barometer">GfK Consumer Confidence Barometer</a>, also a monthly survey of households. </p>
<p>Both measures ask people about their personal finances and their thoughts on the general economy. Participants are asked about plans for large purchases, especially durables such as white goods and cars, as well as their views about what has happened in the past year (backward-looking) and their opinion of prospects over the next year (forward-looking). The US index is more focused on households’ forward-looking views, at least with regards to the overall economy.</p>
<figure class="align-center ">
<img alt="Woman standing between two rows of new washing machines in a shop." src="https://images.theconversation.com/files/567596/original/file-20240102-19-sy2cdn.jpg?ixlib=rb-1.1.0&q=45&auto=format&w=754&fit=clip" srcset="https://images.theconversation.com/files/567596/original/file-20240102-19-sy2cdn.jpg?ixlib=rb-1.1.0&q=45&auto=format&w=600&h=400&fit=crop&dpr=1 600w, https://images.theconversation.com/files/567596/original/file-20240102-19-sy2cdn.jpg?ixlib=rb-1.1.0&q=30&auto=format&w=600&h=400&fit=crop&dpr=2 1200w, https://images.theconversation.com/files/567596/original/file-20240102-19-sy2cdn.jpg?ixlib=rb-1.1.0&q=15&auto=format&w=600&h=400&fit=crop&dpr=3 1800w, https://images.theconversation.com/files/567596/original/file-20240102-19-sy2cdn.jpg?ixlib=rb-1.1.0&q=45&auto=format&w=754&h=503&fit=crop&dpr=1 754w, https://images.theconversation.com/files/567596/original/file-20240102-19-sy2cdn.jpg?ixlib=rb-1.1.0&q=30&auto=format&w=754&h=503&fit=crop&dpr=2 1508w, https://images.theconversation.com/files/567596/original/file-20240102-19-sy2cdn.jpg?ixlib=rb-1.1.0&q=15&auto=format&w=754&h=503&fit=crop&dpr=3 2262w" sizes="(min-width: 1466px) 754px, (max-width: 599px) 100vw, (min-width: 600px) 600px, 237px">
<figcaption>
<span class="caption">Economists are interested in people’s future spending plans for large items like washing machines.</span>
<span class="attribution"><a class="source" href="https://www.shutterstock.com/image-photo/hard-decision-lady-choosing-between-two-2116392398">UfaBizPhoto/Shutterstock</a></span>
</figcaption>
</figure>
<h2>Why are these consumer surveys so important?</h2>
<p>People’s willingness to spend money is affected by <a href="https://doi.org/10.1002/jae.2494">special or extreme events</a>. The financial crisis of 2007-08, the COVID pandemic and Russia’s invasion of Ukraine all dragged down consumer sentiment.</p>
<p><a href="http://dx.doi.org/10.1016/j.jmacro.2009.12.002">Recent research</a> also shows that good and bad news has an uneven effect on consumer sentiment. In particular, good news about the general economy will have a greater and more lasting impact than bad news.</p>
<p>In the US, for example, recent good news about jobless rates falling to the lowest point since July, together with the future prospect of lower inflation, has boosted households’ willingness to consume. After falling continually for the preceding four months, US consumer sentiment increased sharply in December. </p>
<figure class="align-center zoomable">
<a href="https://images.theconversation.com/files/566907/original/file-20231220-29-ibs01t.png?ixlib=rb-1.1.0&q=45&auto=format&w=1000&fit=clip"><img alt="Chart with line (representing consumer confidence) falling recently and then rising again in the last month." src="https://images.theconversation.com/files/566907/original/file-20231220-29-ibs01t.png?ixlib=rb-1.1.0&q=45&auto=format&w=754&fit=clip" srcset="https://images.theconversation.com/files/566907/original/file-20231220-29-ibs01t.png?ixlib=rb-1.1.0&q=45&auto=format&w=600&h=360&fit=crop&dpr=1 600w, https://images.theconversation.com/files/566907/original/file-20231220-29-ibs01t.png?ixlib=rb-1.1.0&q=30&auto=format&w=600&h=360&fit=crop&dpr=2 1200w, https://images.theconversation.com/files/566907/original/file-20231220-29-ibs01t.png?ixlib=rb-1.1.0&q=15&auto=format&w=600&h=360&fit=crop&dpr=3 1800w, https://images.theconversation.com/files/566907/original/file-20231220-29-ibs01t.png?ixlib=rb-1.1.0&q=45&auto=format&w=754&h=452&fit=crop&dpr=1 754w, https://images.theconversation.com/files/566907/original/file-20231220-29-ibs01t.png?ixlib=rb-1.1.0&q=30&auto=format&w=754&h=452&fit=crop&dpr=2 1508w, https://images.theconversation.com/files/566907/original/file-20231220-29-ibs01t.png?ixlib=rb-1.1.0&q=15&auto=format&w=754&h=452&fit=crop&dpr=3 2262w" sizes="(min-width: 1466px) 754px, (max-width: 599px) 100vw, (min-width: 600px) 600px, 237px"></a>
<figcaption>
<span class="caption">Consumer confidence in the US economy has risen in recent months.</span>
<span class="attribution"><a class="source" href="https://data.sca.isr.umich.edu/">Author provided using data from Survey of Consumers, University of Michigan</a>, <a class="license" href="http://creativecommons.org/licenses/by-nc-nd/4.0/">CC BY-NC-ND</a></span>
</figcaption>
</figure>
<p>The US Federal Reserve has indicated that <a href="https://www.cnbc.com/2023/12/13/fed-interest-rate-decision-december-2023.html">interest rates will be held</a> and perhaps even fall in 2024 as inflationary pressures ease. So, the outlook for an easing of inflationary pressures once recent interest rate rises take full effect seems to have had a positive effect on consumer sentiment.</p>
<h2>A gloomier outlook for the UK economy</h2>
<p>The picture in the UK is somewhat different. While inflationary pressures have eased recently, the <a href="https://www.ons.gov.uk/economy/inflationandpriceindices/bulletins/consumerpriceinflation/november2023#main-points">current rate</a> of 3.9% is still well above the Bank of England’s 2% target. Also, unlike the US Federal Reserve, the Bank of England is less likely to cut interest rates anytime soon, while recent data on <a href="https://www.bbc.co.uk/news/business-67690287">economic growth has been disappointing</a>. In October, the economy shrank by 0.3% and unemployment rates are currently around 4.3%, with pay growth easing.</p>
<figure class="align-center zoomable">
<a href="https://images.theconversation.com/files/566910/original/file-20231220-17-4ord34.png?ixlib=rb-1.1.0&q=45&auto=format&w=1000&fit=clip"><img alt="Chart with zig-zagging line (recently), showing an upward turn most recently." src="https://images.theconversation.com/files/566910/original/file-20231220-17-4ord34.png?ixlib=rb-1.1.0&q=45&auto=format&w=754&fit=clip" srcset="https://images.theconversation.com/files/566910/original/file-20231220-17-4ord34.png?ixlib=rb-1.1.0&q=45&auto=format&w=600&h=342&fit=crop&dpr=1 600w, https://images.theconversation.com/files/566910/original/file-20231220-17-4ord34.png?ixlib=rb-1.1.0&q=30&auto=format&w=600&h=342&fit=crop&dpr=2 1200w, https://images.theconversation.com/files/566910/original/file-20231220-17-4ord34.png?ixlib=rb-1.1.0&q=15&auto=format&w=600&h=342&fit=crop&dpr=3 1800w, https://images.theconversation.com/files/566910/original/file-20231220-17-4ord34.png?ixlib=rb-1.1.0&q=45&auto=format&w=754&h=430&fit=crop&dpr=1 754w, https://images.theconversation.com/files/566910/original/file-20231220-17-4ord34.png?ixlib=rb-1.1.0&q=30&auto=format&w=754&h=430&fit=crop&dpr=2 1508w, https://images.theconversation.com/files/566910/original/file-20231220-17-4ord34.png?ixlib=rb-1.1.0&q=15&auto=format&w=754&h=430&fit=crop&dpr=3 2262w" sizes="(min-width: 1466px) 754px, (max-width: 599px) 100vw, (min-width: 600px) 600px, 237px"></a>
<figcaption>
<span class="caption">Consumer confidence in the UK remains in negative territory but people are feeling more optimistic.</span>
<span class="attribution"><a class="source" href="https://www.gfk.com/press/nov-uk-consumer-confidence-stages-end-of-year-rally">Author provided using data from GfK</a>, <a class="license" href="http://creativecommons.org/licenses/by-nc-nd/4.0/">CC BY-NC-ND</a></span>
</figcaption>
</figure>
<p>Nevertheless, consumer confidence has increased in the last two months, after a sharp fall in October. That decrease may have been due to the Gaza conflict and fears about its potential impact on the global economy.</p>
<hr>
<p>
<em>
<strong>
Read more:
<a href="https://theconversation.com/how-the-israel-hamas-war-could-affect-the-world-economy-and-worsen-global-trade-tensions-215930">How the Israel-Hamas war could affect the world economy and worsen global trade tensions</a>
</strong>
</em>
</p>
<hr>
<p>So, both UK and US consumers seem to feel fairly optimistic about their personal finances and the wider economy right now. The obvious common factor among the two economies is the easing of inflationary pressures, which many people will be hoping will reduce the pressures of the cost of living crisis. But even though confidence is growing, neither country is out of the woods yet when it comes to the economic outlook.</p><img src="https://counter.theconversation.com/content/219858/count.gif" alt="The Conversation" width="1" height="1" />
<p class="fine-print"><em><span>Joshy Easaw received a Leverhulme Research Fellowship from October 2007 to September 2008 to study: ‘Microfoundations of how households form subjective macroeconomic expectations: The role of news’.</span></em></p>Levels of consumer confidence can signal people’s future spending plans and the likely impact on the economy.Joshy Easaw, Professor of Economics, Cardiff UniversityLicensed as Creative Commons – attribution, no derivatives.tag:theconversation.com,2011:article/2186782024-01-03T17:41:33Z2024-01-03T17:41:33ZMortgage rates are falling but borrowers are still feeling the squeeze – a finance expert explains how to cut your repayments<figure><img src="https://images.theconversation.com/files/567069/original/file-20231221-15-qtv8aw.jpg?ixlib=rb-1.1.0&rect=25%2C8%2C5582%2C3682&q=45&auto=format&w=496&fit=clip" /><figcaption><span class="caption">
</span> <span class="attribution"><a class="source" href="https://www.shutterstock.com/image-photo/unhappy-depressed-young-africanamerican-couple-calculating-592973699">Cast Of Thousands/Shutterstock</a></span></figcaption></figure><p>Around <a href="https://www.bankofengland.co.uk/financial-stability-report/2023/december-2023#downloads">5 million households</a> have seen their mortgage interest rate change since the Bank of England base rate started to rise in late 2021. Over the course of the 2023 alone, the base rate increased from <a href="https://www.bankofengland.co.uk/monetary-policy/the-interest-rate-bank-rate">3.5% to 5.25%</a>, surpassing <a href="https://www.ft.com/content/955b568a-c924-421a-bc0f-caa85d37007b">economists’ expectations</a> and pushing mortgage rates to the highest levels since 2008. For some people, repayments have increased by hundreds of pounds overnight.</p>
<p>Many people facing increased monthly mortgage payments were already managing stretched budgets due to the rising cost of living. Inflation for households with mortgages is estimated to be the <a href="https://www.ft.com/content/3d1b54dc-c0bf-4dd7-9c11-054eba3160c1">highest for any socio-economic group</a>.</p>
<p>Some households have chosen to reduce the pressure by remortgaging over a longer term. Mortgages of <a href="https://www.bankofengland.co.uk/financial-stability-report/2023/december-2023#downloads">35 years or more</a> have increased from around 5% to 12% of the market in the last two years. What’s more, 28% of new owner-occupier mortgages were agreed on terms longer than 30 years. </p>
<p>People that want to get on the property ladder – particularly millennials, the oldest of whom are now reaching their mid-30s – are instead being forced to continue to rent, even as rents <a href="https://www.theguardian.com/money/2023/dec/11/tenants-in-britain-hit-by-highest-increase-in-rent-for-a-decade-last-month?ref=biztoc.com">soar by 10.2%</a>. The resulting drop in demand for homeloans can be seen in the figures for new mortgage approvals for home purchases, which averaged around 47,000 per month in 2023 (as of October), well below the pre-pandemic average of 65,000 approvals. </p>
<p>Total mortgage lending fell by 25% in 2023 and <a href="https://www.ukfinance.org.uk/system/files/2023-12/Mortgage%20Market%20Forecasts%202024-2025.pdf">is not expected to recover in 2024</a>.</p>
<p><strong>Mortgage lending has fallen recently</strong></p>
<figure class="align-center zoomable">
<a href="https://images.theconversation.com/files/566084/original/file-20231215-27-jp25vj.png?ixlib=rb-1.1.0&q=45&auto=format&w=1000&fit=clip"><img alt="Bar chart showing mortgage lending falling recently." src="https://images.theconversation.com/files/566084/original/file-20231215-27-jp25vj.png?ixlib=rb-1.1.0&q=45&auto=format&w=754&fit=clip" srcset="https://images.theconversation.com/files/566084/original/file-20231215-27-jp25vj.png?ixlib=rb-1.1.0&q=45&auto=format&w=600&h=278&fit=crop&dpr=1 600w, https://images.theconversation.com/files/566084/original/file-20231215-27-jp25vj.png?ixlib=rb-1.1.0&q=30&auto=format&w=600&h=278&fit=crop&dpr=2 1200w, https://images.theconversation.com/files/566084/original/file-20231215-27-jp25vj.png?ixlib=rb-1.1.0&q=15&auto=format&w=600&h=278&fit=crop&dpr=3 1800w, https://images.theconversation.com/files/566084/original/file-20231215-27-jp25vj.png?ixlib=rb-1.1.0&q=45&auto=format&w=754&h=349&fit=crop&dpr=1 754w, https://images.theconversation.com/files/566084/original/file-20231215-27-jp25vj.png?ixlib=rb-1.1.0&q=30&auto=format&w=754&h=349&fit=crop&dpr=2 1508w, https://images.theconversation.com/files/566084/original/file-20231215-27-jp25vj.png?ixlib=rb-1.1.0&q=15&auto=format&w=754&h=349&fit=crop&dpr=3 2262w" sizes="(min-width: 1466px) 754px, (max-width: 599px) 100vw, (min-width: 600px) 600px, 237px"></a>
<figcaption>
<span class="caption"></span>
<span class="attribution"><a class="source" href="https://www.ukfinance.org.uk/system/files/2023-12/Mortgage%20Market%20Forecasts%202024-2025.pdf">Author provided using data from UK Finance</a>, <a class="license" href="http://creativecommons.org/licenses/by-nc-nd/4.0/">CC BY-NC-ND</a></span>
</figcaption>
</figure>
<h2>Where are rates headed in 2024?</h2>
<p>Signs that households are struggling to keep up with mortgage payments are getting stronger, with <a href="https://www.ftadviser.com/mortgages/2023/12/07/more-homeowners-falling-into-mortgage-arrears/">more people now falling into arrears</a>. Although less severe than previously forecast, industry body UK Finance expects arrears and possessions to <a href="https://www.ukfinance.org.uk/system/files/2023-12/Household%20Finance%20Review%202023%20Q3.pdf">continue to rise</a>.</p>
<p><strong>Arrears and repossessions are rising</strong></p>
<figure class="align-center zoomable">
<a href="https://images.theconversation.com/files/566085/original/file-20231215-29-yf4qeq.png?ixlib=rb-1.1.0&q=45&auto=format&w=1000&fit=clip"><img alt="Chart showing arrears rising recently (blue bars) and repossessions (red line)." src="https://images.theconversation.com/files/566085/original/file-20231215-29-yf4qeq.png?ixlib=rb-1.1.0&q=45&auto=format&w=754&fit=clip" srcset="https://images.theconversation.com/files/566085/original/file-20231215-29-yf4qeq.png?ixlib=rb-1.1.0&q=45&auto=format&w=600&h=282&fit=crop&dpr=1 600w, https://images.theconversation.com/files/566085/original/file-20231215-29-yf4qeq.png?ixlib=rb-1.1.0&q=30&auto=format&w=600&h=282&fit=crop&dpr=2 1200w, https://images.theconversation.com/files/566085/original/file-20231215-29-yf4qeq.png?ixlib=rb-1.1.0&q=15&auto=format&w=600&h=282&fit=crop&dpr=3 1800w, https://images.theconversation.com/files/566085/original/file-20231215-29-yf4qeq.png?ixlib=rb-1.1.0&q=45&auto=format&w=754&h=355&fit=crop&dpr=1 754w, https://images.theconversation.com/files/566085/original/file-20231215-29-yf4qeq.png?ixlib=rb-1.1.0&q=30&auto=format&w=754&h=355&fit=crop&dpr=2 1508w, https://images.theconversation.com/files/566085/original/file-20231215-29-yf4qeq.png?ixlib=rb-1.1.0&q=15&auto=format&w=754&h=355&fit=crop&dpr=3 2262w" sizes="(min-width: 1466px) 754px, (max-width: 599px) 100vw, (min-width: 600px) 600px, 237px"></a>
<figcaption>
<span class="caption"></span>
<span class="attribution"><a class="source" href="https://www.ukfinance.org.uk/system/files/2023-12/Mortgage%20Market%20Forecasts%202024-2025.pdf">Author provided using data from UK Finance</a>, <a class="license" href="http://creativecommons.org/licenses/by-nc-nd/4.0/">CC BY-NC-ND</a></span>
</figcaption>
</figure>
<p>And as more homeowners come off the cheap fixed rates of pre-2022 period, around <a href="https://www.bankofengland.co.uk/financial-stability-report/2023/december-2023">2.3 million households are expected to face higher rates in 2024</a>, with an average monthly repayment increase of £240. The Bank of England has forecast that around <a href="https://www.bankofengland.co.uk/financial-stability-report/2023/december-2023">440,000 households will struggle to afford</a> these increases. </p>
<p>There is some good news: <a href="https://www.investopedia.com/terms/i/impliedrate.asp#:%7E:text=The%20implied%20rate%20is%20an%20interest%20rate%20equal,that%20also%20has%20an%20option%20or%20futures%20contract.">market expectations</a> are for the Bank of England base rate to fall. It is expected to ease to around <a href="https://www.bankofengland.co.uk/monetary-policy-report/2023/november-2023?ref=pmp-magazine.com#report-november">4.25% by the end of 2026</a>, from 5.25% right now. So, we may well have <a href="https://www.nationwidehousepriceindex.co.uk/reports/house-price-recovery-continued-in-november#:%7E:text=significant%20change%20in%20market%20expectations">passed the peak</a> for interest rates.</p>
<p><strong>Expectations for the Bank of England base rate are changing</strong></p>
<figure class="align-center zoomable">
<a href="https://images.theconversation.com/files/565483/original/file-20231213-15-23350.png?ixlib=rb-1.1.0&q=45&auto=format&w=1000&fit=clip"><img alt="Chart showing changing expectations for the Bank of England base rate." src="https://images.theconversation.com/files/565483/original/file-20231213-15-23350.png?ixlib=rb-1.1.0&q=45&auto=format&w=754&fit=clip" srcset="https://images.theconversation.com/files/565483/original/file-20231213-15-23350.png?ixlib=rb-1.1.0&q=45&auto=format&w=600&h=333&fit=crop&dpr=1 600w, https://images.theconversation.com/files/565483/original/file-20231213-15-23350.png?ixlib=rb-1.1.0&q=30&auto=format&w=600&h=333&fit=crop&dpr=2 1200w, https://images.theconversation.com/files/565483/original/file-20231213-15-23350.png?ixlib=rb-1.1.0&q=15&auto=format&w=600&h=333&fit=crop&dpr=3 1800w, https://images.theconversation.com/files/565483/original/file-20231213-15-23350.png?ixlib=rb-1.1.0&q=45&auto=format&w=754&h=418&fit=crop&dpr=1 754w, https://images.theconversation.com/files/565483/original/file-20231213-15-23350.png?ixlib=rb-1.1.0&q=30&auto=format&w=754&h=418&fit=crop&dpr=2 1508w, https://images.theconversation.com/files/565483/original/file-20231213-15-23350.png?ixlib=rb-1.1.0&q=15&auto=format&w=754&h=418&fit=crop&dpr=3 2262w" sizes="(min-width: 1466px) 754px, (max-width: 599px) 100vw, (min-width: 600px) 600px, 237px"></a>
<figcaption>
<span class="caption"></span>
<span class="attribution"><a class="source" href="https://www.nationwidehousepriceindex.co.uk/reports/house-price-recovery-continued-in-november">Nationwide House Price Index, using Bank of England data</a></span>
</figcaption>
</figure>
<p>Mortgage rates (which are generally tied to the base rate) have already dropped since September, when the <a href="https://edu.bankofengland.co.uk/-/media/boe/files/monetary-policy-summary-and-minutes/2023/monetary-policy-summary-and-minutes-september-2023.pdf#:%7E:text=The%20Bank%20of%20England%E2%80%99s%20Monetary%20Policy%20Committee%20%28MPC%29,of%205%E2%80%934%20to%20maintain%20Bank%20Rate%20at%205.25%25.">Bank of England decided to hold</a> the base rate as inflation slowed. In early January, Halifax cut some rates by nearly 0.8% and HSBC also announced reductions for certain products. Mortgage <a href="https://www.bbc.co.uk/news/business-67873017">brokers believe</a> this could encourage more rate cuts by other lenders.</p>
<p>Rates still remain high compared to recent years, but this downward trend will continue to help household finances this year. For the average <a href="https://www.statista.com/statistics/915977/average-value-of-mortgage-granted-in-the-united-kingdom/">£200,000 mortgage</a>, for example, a 1% drop from 5.8% to 4.8% would lead to yearly savings of around £2,000.</p>
<p>But it’s unrealistic to expect the mortgage rates to return to the <a href="https://theconversation.com/why-mortgage-rates-will-not-return-to-recent-lows-any-time-soon-201619">325-year lows</a> observed between 2008 and 2021. Furthermore, a third of the Monetary Policy Committee – the team that decides what the Bank of England base rate should be – are still <a href="https://www.bankofengland.co.uk/monetary-policy-summary-and-minutes/2023/december-2023">keen to increase the base rate</a> to meet the Bank of England’s <a href="https://edu.bankofengland.co.uk/explainers/what-is-inflation#:%7E:text=A%20low%20and%20stable%20rate%20of%20inflation%20helps,England%20job%20to%20keep%20inflation%20at%20that%20target.">2% inflation target</a>. The current level of inflation is <a href="https://www.ons.gov.uk/">4.2%</a>. </p>
<p>So, UK homeowners may not be out of the woods yet. Further rate cuts will depend on the future course of inflation, which is difficult to predict because it’s influenced by many external factors – energy and food prices can be affected by wars and other global crises.</p>
<hr>
<p>
<em>
<strong>
Read more:
<a href="https://theconversation.com/five-ways-to-reduce-your-mortgage-repayments-in-2023-and-why-rates-have-risen-so-high-196327">Five ways to reduce your mortgage repayments in 2023 – and why rates have risen so high</a>
</strong>
</em>
</p>
<hr>
<h2>What to do if you need a mortgage in 2024</h2>
<p>To start with, consider seeking advice from a qualified, independent mortgage advisor. They can discuss your personal circumstances with you. They also may have access to better deals than you can find yourself online or through your bank.</p>
<p>If you are a first-time buyer, since the Bank of England is expected to hold rates for now, it may be sensible to wait for rates to ease a bit more. During this time, save as much as you can towards your deposit. Both will help to reduce your borrowing costs. However, there is always the risk that rates and inflation stop falling or slowing due to unexpected changes in the economic and political environment.</p>
<p>If your budget is tight and you are worried about affording increased repayments in the future, extending your mortgage term would reduce monthly payments. But it will take longer to pay off your mortgage as a result. You may be able to make <a href="https://www.moneysupermarket.com/mortgages/mortgage-overpayments/">overpayments</a> in the future to catch up if your financial situation changes, but this is typically limited to 10% of the balance per year.</p>
<p>Another alternative is to temporarily switch to <a href="https://www.unbiased.co.uk/discover/mortgages-property/buying-a-home/what-is-an-interest-only-mortgage-how-do-repayments-work">interest-only repayments</a> for a couple of years. This means you are not paying off the money you have borrowed, just the interest. Once the rates are lower you can switch back to a repayment mortgage. But again, this will lengthen the time it takes to pay off your mortgage.</p>
<p>If you are on a fixed-rate mortgage that is about to end in 2024, make sure to check your lender’s standard variable rate (SVR). This is the rate you will automatically move on to if you do not remortgage. But SVRs are often the highest rates around, so it may be best to look for a better deal before your current rate ends.</p>
<p>If your home is one of the <a href="https://www.gov.uk/government/statistics/help-to-buy-equity-loan-scheme-data-to-30-september-2022/help-to-buy-equity-loan-scheme-data-to-30-september-2022">375,654 properties</a> bought via the government’s help-to-buy loan scheme, check how much you will be charged if you continue with your current deal. The rates under these schemes can be more <a href="https://www.moneyhelper.org.uk/en/homes/buying-a-home/help-to-buy-scheme-everything-you-need-to-know">competitive than normal market rates</a>. However, keep in mind that you will share any future capital gain with the government if your home increases in value as the scheme owns a share of it (typically a maximum of 20%). </p>
<p>Recently, the UK’s mortgage lenders agreed with the government on a number of measures <a href="https://www.gov.uk/government/news/chancellor-agrees-new-support-measures-for-mortgage-holders">to support people struggling</a> with their mortgage repayments. So, if you are worried, it’s best to talk to your bank in advance about how it can help.</p><img src="https://counter.theconversation.com/content/218678/count.gif" alt="The Conversation" width="1" height="1" />
<p class="fine-print"><em><span>Alper Kara does not work for, consult, own shares in or receive funding from any company or organisation that would benefit from this article, and has disclosed no relevant affiliations beyond their academic appointment.</span></em></p>Homeowners looking to remortgage and first-time buyers struggled to manage interest rate hikes in 2023. Here’s what to think about this year.Alper Kara, Professor of Banking and Finance, Brunel University LondonLicensed as Creative Commons – attribution, no derivatives.tag:theconversation.com,2011:article/2198572023-12-19T16:54:29Z2023-12-19T16:54:29ZInterest rates have stopped rising, but 2023 hikes could still cause recession for some economies<figure><img src="https://images.theconversation.com/files/566140/original/file-20231217-29-oomab8.jpg?ixlib=rb-1.1.0&rect=40%2C17%2C2946%2C1949&q=45&auto=format&w=496&fit=clip" /><figcaption><span class="caption">Central banks in the US, UK and Europe have been trying to slow inflation without creating a recession.</span> <span class="attribution"><a class="source" href="https://www.shutterstock.com/image-vector/inflation-reduction-act-by-fed-federal-2218228849">eamesBot/Shutterstock</a></span></figcaption></figure><p>Central banks on both sides of the Atlantic kept their main interest rates unchanged for the fourth successive month in December 2023. These rates are closely watched because they set the minimum interest at which your bank borrows and lends. This determines the cost of credit for all firms and households with mortgages or other loans. </p>
<p>The European Central Bank (ECB), the US Federal Reserve and the UK Bank of England have raised interest rates sharply since the start of 2022. This was in response to a surge in inflation – the annual increase in consumer prices – far above the 2% rate that all these central banks now target. </p>
<p>But UK inflation is taking longer to respond than that of the US or EU. This has renewed debate over <a href="https://theconversation.com/interest-rate-hikes-are-not-the-only-tool-to-fight-uk-inflation-heres-what-the-government-should-do-208697">whether rate cuts are the best or only way</a> to keep inflation under control. It has also caused a shift in opinions about which western economies are most at risk of recession in 2024.</p>
<hr>
<p>
<em>
<strong>
Read more:
<a href="https://theconversation.com/is-the-uk-in-a-recession-how-central-banks-decide-and-why-its-so-hard-to-call-it-191237">Is the UK in a recession? How central banks decide and why it's so hard to call it</a>
</strong>
</em>
</p>
<hr>
<p>Higher interest rates are designed to subdue inflation by reducing the amount people spend. Businesses and households are expected to save more when rates rise, in anticipation of greater interest payments (<a href="https://theconversation.com/interest-rates-why-your-mortgage-payments-are-going-up-but-your-savings-arent-and-how-better-monetary-policy-could-help-196528">although that doesn’t always happen</a>). It’s also hoped they’ll borrow less because of the extra interest they would be charged. Those with outstanding loans are left with less to spend on goods and services after paying their interest bill. </p>
<p>Governments are also affected. In the UK, interest on around a quarter of government debt is now <a href="https://www.nao.org.uk/press-releases/managing-government-borrowing/#:%7E:text=The%20type%20of%20debt%20that,to%20lenders%20rise%20with%20inflation.">linked to inflation</a>. This means more of the budget gets channelled into interest payments, leaving less to spend on public services, when the central bank raises rates.</p>
<p>This restraint doesn’t happen immediately, however. When borrowers take out fixed-rate loans, they aren’t affected by higher base rates until the deal expires. Almost a million UK borrowers, for example, are still on fixed rates of 2% or below that will only <a href="https://www.ons.gov.uk/peoplepopulationandcommunity/housing/articles/howincreasesinhousingcostsimpacthouseholds/2023-01-09">come up for renewal</a> – at current, higher rates – in the first quarter of 2024. The resulting delay of a year or more before past interest rate rises kick in makes it hard for central bankers to know when they’ve raised rates enough to cool the economy.</p>
<hr>
<p>
<em>
<strong>
Read more:
<a href="https://theconversation.com/uk-bonds-have-hit-a-25-year-high-heres-what-that-means-for-the-economy-215188">UK bonds have hit a 25-year high – here's what that means for the economy</a>
</strong>
</em>
</p>
<hr>
<p>Raising interest rates can also restrain inflation by encouraging foreign investors to buy bonds and other financial assets in a country’s currency. The resulting inflow of capital is likely to strengthen its exchange rate. This makes imports cheaper and can help to slow the overall rise in prices. </p>
<p>A stronger currency is especially effective for curbing inflation for economies that consume a high proportion of imports, such as the UK. But it also hurts exporters, and only works if interest rates rise above those of comparable economies. This may be one reason why the Bank of England has raised its interest rates faster and further than the ECB since February 2022.</p>
<figure class="align-center zoomable">
<a href="https://images.theconversation.com/files/566141/original/file-20231217-15-zjp7ej.jpeg?ixlib=rb-1.1.0&q=45&auto=format&w=1000&fit=clip"><img alt="Line chart showing the main central bank rates for UK, US, Europe staying low from 2012-2016 (except the US) and then rapidly rising at the end of 2021. Also shows Japan, which has stayed low thoughout." src="https://images.theconversation.com/files/566141/original/file-20231217-15-zjp7ej.jpeg?ixlib=rb-1.1.0&q=45&auto=format&w=754&fit=clip" srcset="https://images.theconversation.com/files/566141/original/file-20231217-15-zjp7ej.jpeg?ixlib=rb-1.1.0&q=45&auto=format&w=600&h=600&fit=crop&dpr=1 600w, https://images.theconversation.com/files/566141/original/file-20231217-15-zjp7ej.jpeg?ixlib=rb-1.1.0&q=30&auto=format&w=600&h=600&fit=crop&dpr=2 1200w, https://images.theconversation.com/files/566141/original/file-20231217-15-zjp7ej.jpeg?ixlib=rb-1.1.0&q=15&auto=format&w=600&h=600&fit=crop&dpr=3 1800w, https://images.theconversation.com/files/566141/original/file-20231217-15-zjp7ej.jpeg?ixlib=rb-1.1.0&q=45&auto=format&w=754&h=754&fit=crop&dpr=1 754w, https://images.theconversation.com/files/566141/original/file-20231217-15-zjp7ej.jpeg?ixlib=rb-1.1.0&q=30&auto=format&w=754&h=754&fit=crop&dpr=2 1508w, https://images.theconversation.com/files/566141/original/file-20231217-15-zjp7ej.jpeg?ixlib=rb-1.1.0&q=15&auto=format&w=754&h=754&fit=crop&dpr=3 2262w" sizes="(min-width: 1466px) 754px, (max-width: 599px) 100vw, (min-width: 600px) 600px, 237px"></a>
<figcaption>
<span class="caption"></span>
<span class="attribution"><a class="source" href="https://www.statista.com/chart/21070/main-policy-interest-rates-in-selected-countries-and-regions/">Statista</a>, <a class="license" href="http://creativecommons.org/licenses/by/4.0/">CC BY</a></span>
</figcaption>
</figure>
<h2>Divergence ahead</h2>
<p>Although they hiked rates in similar fashion in 2022-23, these central banks are set to go different ways in 2024. </p>
<p>US rates are set to fall as inflation drops back towards the 2% target, having already slowed to 3.1% in November 2023 (from 6.4% in January). The US Federal Reserve has signalled two likely interest rate reductions, totalling 0.75%, in 2024. That’s falling into line with investors’ expectations, which can be gauged by the prices they’re prepared to pay for <a href="https://www.chathamfinancial.com/insights/what-is-a-forward-curve">trading or swapping</a> debt due at a future date and by interest rates on <a href="https://data.oecd.org/interest/long-term-interest-rates-forecast.htm">government bonds that mature several years from now</a>.</p>
<p>While the ECB’s forward guidance is less clear, its governor <a href="https://www.ecb.europa.eu/press/pressconf/2023/html/ecb.is231214%7Edf8627de60.en.html">has hinted at</a> a similar downward path in 2024 because projections now point to headline inflation dropping to 2.1% in 2025 – a year earlier than previously predicted. Eurozone inflation has already slowed sharply, to 2.4% in November from 8.5% in February 2023, despite the ECB keeping its interest rates lower than the US and UK throughout the recent tightening phase. That’s largely because, even though member states set their own fiscal policy, EU rules keep them on <a href="https://economy-finance.ec.europa.eu/system/files/2023-04/COM_2023_240_1_EN.pdf">a tight rein</a> when it comes to spending and debt levels.</p>
<p>In contrast the Bank of England has warned that its base rate, already higher than the EU’s, is likely to stay at 5.25% <a href="https://www.ft.com/content/6425c756-0ff7-42f3-9022-01be30da07fd">“for an extended period of time”</a>. Inflation (on its targeted consumer price index) slowed to <a href="https://www.ons.gov.uk/economy/inflationandpriceindices/timeseries/d7g7/mm23">4.6% in October</a>, well down from its peak above 11% in October 2022, but the average household is braced for more cost of living increases including <a href="https://www.gov.uk/government/publications/energy-bills-support/energy-bills-support-factsheet-8-september-2022">a mid-winter 5% rise</a> in the energy price cap. The recent <a href="https://www.cnbc.com/2023/10/03/sterling-had-its-worst-month-for-a-year-and-it-may-fall-further.html">weakening of the pound</a> against the dollar has also added to industries’ raw material costs, and could worsen if UK interest rates fall too soon. </p>
<hr>
<p>
<em>
<strong>
Read more:
<a href="https://theconversation.com/inflation-has-affected-the-uk-us-and-europe-differently-heres-what-this-means-for-interest-rates-218561">Inflation has affected the UK, US and Europe differently – here's what this means for interest rates</a>
</strong>
</em>
</p>
<hr>
<h2>Recession threat isn’t over</h2>
<p>The UK economy, while hardly growing this year, has defied the Bank’s earlier <a href="https://www.bankofengland.co.uk/monetary-policy-report/2022/august-2022">forecast of a recession</a> from the end of 2022. But because this encouraged the bank into another near-doubling of base rates – from 2.25% in October 2022 to 5.25% from August 2023 – a UK recession in 2024 is still <a href="https://www.fitchsolutions.com/bmi/country-risk/uk-recession-2024-sluggish-rebound-bond-rollovers-take-their-toll-27-10-2023">expected by some commentators</a>. Unfortunately, consumer spending has been <a href="https://www.imf.org/en/Publications/selected-issues-papers/Issues/2023/07/13/Enhancing-Business-Investment-in-the-United-Kingdom-536320">less affected</a> by higher borrowing costs than private and public investment, which ultimately drive economic growth. </p>
<p>More ominously for US president Joe Biden, current interest rate patterns suggest the US could also be <a href="https://www.usbank.com/investing/financial-perspectives/market-news/treasury-yields-invert-as-investors-weigh-risk-of-recession.html">heading for recession</a> in a presidential election year. Most US GDP forecasts for 2024 remain in the 1.5-2.0% range, but that’s well down from the <a href="https://www.bea.gov/news/2023/gross-domestic-product-third-quarter-2023-advance-estimate">4.9% reached in third-quarter 2023</a>. Against this backdrop, the eurozone’s official forecast of <a href="https://economy-finance.ec.europa.eu/economic-forecast-and-surveys/economic-forecasts/autumn-2023-economic-forecast-modest-recovery-ahead-after-challenging-year_en">1.2% growth in 2024</a> could be seen as a relatively strong performance since it’s not expected to slow as much as the US is predicted to in 2024.</p>
<p>So, borrowers already hit by higher costs can expect some relief in 2024. But that’s partly due to growing concern that, with <a href="https://blogs.worldbank.org/developmenttalk/commodity-markets-outlook-eight-charts-0">falling global commodity prices</a> already helping to subdue inflation, central bankers may have applied the brakes too hard since 2022, endangering a global recovery.</p><img src="https://counter.theconversation.com/content/219857/count.gif" alt="The Conversation" width="1" height="1" />
<p class="fine-print"><em><span>Alan Shipman does not work for, consult, own shares in or receive funding from any company or organisation that would benefit from this article, and has disclosed no relevant affiliations beyond their academic appointment.</span></em></p>Market expectations for rate cuts sooner rather than later have been dashed but some economies remain in danger of recession.Alan Shipman, Senior Lecturer in Economics, The Open UniversityLicensed as Creative Commons – attribution, no derivatives.tag:theconversation.com,2011:article/2185612023-11-29T14:07:35Z2023-11-29T14:07:35ZInflation has affected the UK, US and Europe differently – here’s what this means for interest rates<p>The Bank of England’s governor has <a href="https://www.bbc.co.uk/news/articles/cjrpzxpv90eo">repeatedly warned</a> that it will not cut UK interest rates <a href="https://www.cnbc.com/2023/11/02/bank-of-england-leaves-interest-rates-unchanged.html">any time soon</a>, even with a recent sharp fall in consumer price inflation. </p>
<p>Like central banks in the US and eurozone, the bank has been sharply increasing its base rate to try to tame a spike in inflation. But this has increased the interest people must pay on loans like mortgages, as well as businesses’ financing costs, leading to <a href="https://www.reuters.com/markets/rates-bonds/uk-economy-shows-signs-slowdown-boe-rate-hikes-mount-2023-08-23/">an economic slowdown</a>.</p>
<p>Inflation has roared back around the world over the past two years after many years of “low-flation”. A period of slow consumer price growth since the mid-2010s had left central banks struggling for ways to stimulate economic activity. But how they have tackled inflation since have diverged in line with the specific issues and items driving price growth in each economy. Understanding these differences could shed light on the likely direction of interest rates in the coming months.</p>
<p>When COVID hit and lockdown measures stopped the economy altogether, price pressures fell even more than they had during the low-flation period. Some inflation gauges even turned negative. The world’s major central banks used more monetary stimulus to keep their economies afloat. The eurozone implemented the pandemic emergency purchase programme (<a href="https://www.ecb.europa.eu/mopo/implement/pepp/html/index.en.html">PEPP</a>), while <a href="https://www.bankofengland.co.uk/coronavirus">the UK</a> and <a href="https://www.stlouisfed.org/open-vault/2020/august/fed-response-covid19-pandemic">the US</a> came up with similar measures. </p>
<p>The COVID recession also had a particularly pronounced effect on energy prices – US <a href="https://www.bbc.co.uk/news/business-52350082">oil prices even went negative</a> for a few days in March 2020.</p>
<p>But this shock was temporary. As lockdowns eased throughout the western world in the second half of 2020 and into 2021, the economy jumped back quickly. This happened faster and to a greater extent than anyone had anticipated thanks to the stimulus programmes countries enacted. </p>
<h2>Diverging fortunes</h2>
<p>Of course, since every country didn’t experience this snapback at the same time, global supply chains could not keep up. Production in some countries was still in lockdown, while in others factories were ramping up production as people in recovering countries were starting to buy again. Orders became backlogged and shipments were queued. </p>
<p><a href="https://theconversation.com/global-economy-2023-covid-19-turned-global-supply-chains-upside-down-3-ways-the-pandemic-forced-companies-to-rethink-and-transform-how-they-source-their-products-196764">These bottlenecks</a> led to shortages and price hikes for many goods – from <a href="https://www.cnbc.com/2021/08/25/auto-industry-supply-chains-hit-hardest-during-covid-pandemic-survey.html">cars</a> to <a href="https://www.reuters.com/technology/apples-iphone-shipments-seen-sagging-under-china-disruptions-2022-11-30/">phones</a> to over-the-counter <a href="https://www.fastcompany.com/90828462/from-baby-formula-to-tylenol-2022-was-the-year-in-shortages-but-whats-in-store-for-2023">pain meds and baby formula</a>.</p>
<p>Energy prices also shot up again. Crude oil prices reached pre-pandemic levels by <a href="https://www.investopedia.com/articles/investing/100615/will-oil-prices-go-2017.asp#:%7E:text=9-,WTI%20closed%20out%202020,-at%20around%20%2448">the end of 2020</a> and surpassed them throughout 2021. So even before the Russian invasion of Ukraine in February 2022, energy prices and the reopening of the economy were pushing inflation up.</p>
<hr>
<p>
<em>
<strong>
Read more:
<a href="https://theconversation.com/russia-ukraine-war-has-nearly-doubled-household-energy-costs-worldwide-new-study-200104">Russia–Ukraine war has nearly doubled household energy costs worldwide – new study</a>
</strong>
</em>
</p>
<hr>
<p>The outbreak of the war in Ukraine gave energy prices another jolt, of course – especially natural gas in Europe. This led <a href="https://www.bankofengland.co.uk/explainers/will-inflation-in-the-uk-keep-rising#:%7E:text=For%20example%2C%20if%20there%20is,'cost%2Dpush'%20inflation.">central banks to argue</a> they were fighting global cost-push inflation. This means external factors were pushing up the prices of key goods, leaving central banks with little control. </p>
<p>But a closer look at the figures shows that the inflation stories in the three major economies of the US, UK and eurozone had already started to diverge at this point. Since then, they have become even more different. </p>
<p>In all three, inflation peaked at close to 10% in the second half of 2022, but the drivers differed. The following charts show the major contributors to overall consumer price inflation in each of these regions were energy, food and then services and other goods.</p>
<p>In the eurozone, inflation was mostly due to higher energy and, later, food prices:</p>
<figure class="align-center zoomable">
<a href="https://images.theconversation.com/files/562394/original/file-20231129-17-9eqdfq.png?ixlib=rb-1.1.0&q=45&auto=format&w=1000&fit=clip"><img alt="Line graph showing headline inflation, and that for energy, food and all other items in the Eurozone rising to a peak in October 2022 before falling again." src="https://images.theconversation.com/files/562394/original/file-20231129-17-9eqdfq.png?ixlib=rb-1.1.0&q=45&auto=format&w=754&fit=clip" srcset="https://images.theconversation.com/files/562394/original/file-20231129-17-9eqdfq.png?ixlib=rb-1.1.0&q=45&auto=format&w=600&h=356&fit=crop&dpr=1 600w, https://images.theconversation.com/files/562394/original/file-20231129-17-9eqdfq.png?ixlib=rb-1.1.0&q=30&auto=format&w=600&h=356&fit=crop&dpr=2 1200w, https://images.theconversation.com/files/562394/original/file-20231129-17-9eqdfq.png?ixlib=rb-1.1.0&q=15&auto=format&w=600&h=356&fit=crop&dpr=3 1800w, https://images.theconversation.com/files/562394/original/file-20231129-17-9eqdfq.png?ixlib=rb-1.1.0&q=45&auto=format&w=754&h=447&fit=crop&dpr=1 754w, https://images.theconversation.com/files/562394/original/file-20231129-17-9eqdfq.png?ixlib=rb-1.1.0&q=30&auto=format&w=754&h=447&fit=crop&dpr=2 1508w, https://images.theconversation.com/files/562394/original/file-20231129-17-9eqdfq.png?ixlib=rb-1.1.0&q=15&auto=format&w=754&h=447&fit=crop&dpr=3 2262w" sizes="(min-width: 1466px) 754px, (max-width: 599px) 100vw, (min-width: 600px) 600px, 237px"></a>
<figcaption>
<span class="caption"></span>
<span class="attribution"><a class="source" href="https://data.oecd.org/price/inflation-cpi.htm">Author provided using OECD data.</a></span>
</figcaption>
</figure>
<p>But in the UK the prices of non-energy, non-food items were more important to the inflationary push: </p>
<figure class="align-center zoomable">
<a href="https://images.theconversation.com/files/562397/original/file-20231129-30-8d3izq.png?ixlib=rb-1.1.0&q=45&auto=format&w=1000&fit=clip"><img alt="Line chart showing headline rate of UK inflation and that for energy, food and all other items, rising until October 2022 before falling again." src="https://images.theconversation.com/files/562397/original/file-20231129-30-8d3izq.png?ixlib=rb-1.1.0&q=45&auto=format&w=754&fit=clip" srcset="https://images.theconversation.com/files/562397/original/file-20231129-30-8d3izq.png?ixlib=rb-1.1.0&q=45&auto=format&w=600&h=356&fit=crop&dpr=1 600w, https://images.theconversation.com/files/562397/original/file-20231129-30-8d3izq.png?ixlib=rb-1.1.0&q=30&auto=format&w=600&h=356&fit=crop&dpr=2 1200w, https://images.theconversation.com/files/562397/original/file-20231129-30-8d3izq.png?ixlib=rb-1.1.0&q=15&auto=format&w=600&h=356&fit=crop&dpr=3 1800w, https://images.theconversation.com/files/562397/original/file-20231129-30-8d3izq.png?ixlib=rb-1.1.0&q=45&auto=format&w=754&h=447&fit=crop&dpr=1 754w, https://images.theconversation.com/files/562397/original/file-20231129-30-8d3izq.png?ixlib=rb-1.1.0&q=30&auto=format&w=754&h=447&fit=crop&dpr=2 1508w, https://images.theconversation.com/files/562397/original/file-20231129-30-8d3izq.png?ixlib=rb-1.1.0&q=15&auto=format&w=754&h=447&fit=crop&dpr=3 2262w" sizes="(min-width: 1466px) 754px, (max-width: 599px) 100vw, (min-width: 600px) 600px, 237px"></a>
<figcaption>
<span class="caption"></span>
<span class="attribution"><a class="source" href="https://data.oecd.org/price/inflation-cpi.htm">Author provided using OECD data.</a></span>
</figcaption>
</figure>
<p>As they were in the US:</p>
<figure class="align-center zoomable">
<a href="https://images.theconversation.com/files/562398/original/file-20231129-29-x68ffx.png?ixlib=rb-1.1.0&q=45&auto=format&w=1000&fit=clip"><img alt="Line chart showing headline rate of US inflation and that for energy, food and all other items, rising until October 2022 before falling again." src="https://images.theconversation.com/files/562398/original/file-20231129-29-x68ffx.png?ixlib=rb-1.1.0&q=45&auto=format&w=754&fit=clip" srcset="https://images.theconversation.com/files/562398/original/file-20231129-29-x68ffx.png?ixlib=rb-1.1.0&q=45&auto=format&w=600&h=356&fit=crop&dpr=1 600w, https://images.theconversation.com/files/562398/original/file-20231129-29-x68ffx.png?ixlib=rb-1.1.0&q=30&auto=format&w=600&h=356&fit=crop&dpr=2 1200w, https://images.theconversation.com/files/562398/original/file-20231129-29-x68ffx.png?ixlib=rb-1.1.0&q=15&auto=format&w=600&h=356&fit=crop&dpr=3 1800w, https://images.theconversation.com/files/562398/original/file-20231129-29-x68ffx.png?ixlib=rb-1.1.0&q=45&auto=format&w=754&h=447&fit=crop&dpr=1 754w, https://images.theconversation.com/files/562398/original/file-20231129-29-x68ffx.png?ixlib=rb-1.1.0&q=30&auto=format&w=754&h=447&fit=crop&dpr=2 1508w, https://images.theconversation.com/files/562398/original/file-20231129-29-x68ffx.png?ixlib=rb-1.1.0&q=15&auto=format&w=754&h=447&fit=crop&dpr=3 2262w" sizes="(min-width: 1466px) 754px, (max-width: 599px) 100vw, (min-width: 600px) 600px, 237px"></a>
<figcaption>
<span class="caption"></span>
<span class="attribution"><a class="source" href="https://data.oecd.org/price/inflation-cpi.htm">Author provided using OECD data.</a></span>
</figcaption>
</figure>
<h2>The current inflation picture</h2>
<p>Now the height of the pandemic is behind these economies, supply chain pressures have eased, and energy prices are back to pre-war levels – hence the fall in inflation that’s <a href="https://www.ons.gov.uk/economy/inflationandpriceindices/timeseries/l55o/mm23">now being reported</a> relative to last year. </p>
<p>But the latest headline inflation figures (October 2023) show that another item is now causing these three economies to diverge: housing. </p>
<figure class="align-center zoomable">
<a href="https://images.theconversation.com/files/561929/original/file-20231127-21-z3j90n.png?ixlib=rb-1.1.0&q=45&auto=format&w=1000&fit=clip"><img alt="Three bar charts showing the differing composition of inflation between the US, Eurozone and UK in the October 2023 inflation data." src="https://images.theconversation.com/files/561929/original/file-20231127-21-z3j90n.png?ixlib=rb-1.1.0&q=45&auto=format&w=754&fit=clip" srcset="https://images.theconversation.com/files/561929/original/file-20231127-21-z3j90n.png?ixlib=rb-1.1.0&q=45&auto=format&w=600&h=360&fit=crop&dpr=1 600w, https://images.theconversation.com/files/561929/original/file-20231127-21-z3j90n.png?ixlib=rb-1.1.0&q=30&auto=format&w=600&h=360&fit=crop&dpr=2 1200w, https://images.theconversation.com/files/561929/original/file-20231127-21-z3j90n.png?ixlib=rb-1.1.0&q=15&auto=format&w=600&h=360&fit=crop&dpr=3 1800w, https://images.theconversation.com/files/561929/original/file-20231127-21-z3j90n.png?ixlib=rb-1.1.0&q=45&auto=format&w=754&h=452&fit=crop&dpr=1 754w, https://images.theconversation.com/files/561929/original/file-20231127-21-z3j90n.png?ixlib=rb-1.1.0&q=30&auto=format&w=754&h=452&fit=crop&dpr=2 1508w, https://images.theconversation.com/files/561929/original/file-20231127-21-z3j90n.png?ixlib=rb-1.1.0&q=15&auto=format&w=754&h=452&fit=crop&dpr=3 2262w" sizes="(min-width: 1466px) 754px, (max-width: 599px) 100vw, (min-width: 600px) 600px, 237px"></a>
<figcaption>
<span class="caption">The items that fuelled price inflation in the US, UK and Eurozone headline inflation rates in October 2023.</span>
<span class="attribution"><span class="source">US Bureau of Labor Statistics, Eurostat and UK Office for National Statistics</span></span>
</figcaption>
</figure>
<p>The US and the eurozone have similar headline inflation rates. But in the US, inflation is mainly driven by housing costs (which may be partly due to the way housing costs are measured in the US). In the eurozone, however, energy prices are now dragging down the rate of inflation – although that is offset to a large extent by food prices, which have continued to rise. </p>
<p>On the other hand, the UK has a higher inflation rate and the “all other items” category is now the biggest driver of price rises. So, in the UK, price increases across the board mean that inflationary pressures have spread from a few sectors, like energy or housing, to the broader economy. This makes inflation more sticky and requires more policy tightening to cool down the economy.</p>
<figure class="align-center ">
<img alt="Person holding empty wallet open, over credit cards and bills." src="https://images.theconversation.com/files/561946/original/file-20231127-17-m41f87.jpg?ixlib=rb-1.1.0&q=45&auto=format&w=754&fit=clip" srcset="https://images.theconversation.com/files/561946/original/file-20231127-17-m41f87.jpg?ixlib=rb-1.1.0&q=45&auto=format&w=600&h=400&fit=crop&dpr=1 600w, https://images.theconversation.com/files/561946/original/file-20231127-17-m41f87.jpg?ixlib=rb-1.1.0&q=30&auto=format&w=600&h=400&fit=crop&dpr=2 1200w, https://images.theconversation.com/files/561946/original/file-20231127-17-m41f87.jpg?ixlib=rb-1.1.0&q=15&auto=format&w=600&h=400&fit=crop&dpr=3 1800w, https://images.theconversation.com/files/561946/original/file-20231127-17-m41f87.jpg?ixlib=rb-1.1.0&q=45&auto=format&w=754&h=503&fit=crop&dpr=1 754w, https://images.theconversation.com/files/561946/original/file-20231127-17-m41f87.jpg?ixlib=rb-1.1.0&q=30&auto=format&w=754&h=503&fit=crop&dpr=2 1508w, https://images.theconversation.com/files/561946/original/file-20231127-17-m41f87.jpg?ixlib=rb-1.1.0&q=15&auto=format&w=754&h=503&fit=crop&dpr=3 2262w" sizes="(min-width: 1466px) 754px, (max-width: 599px) 100vw, (min-width: 600px) 600px, 237px">
<figcaption>
<span class="caption">Monetary policy tightening can include rate rises, which increase rates on loans and mortgages.</span>
<span class="attribution"><a class="source" href="https://www.shutterstock.com/image-photo/credit-card-debt-holding-empty-wallet-421745821">Yingzaa_ST/Shutterstock</a></span>
</figcaption>
</figure>
<h2>More interest rate rises to come?</h2>
<p>All of this shows that, in the US and the eurozone there is little sign of broad-based inflation pressures at the moment. If energy prices remain constant and food prices stabilise, inflation might soon return to close to the 2% target most central banks aim for, even without further action by the US Federal Reserve and the European Central Bank. </p>
<p>The UK, by contrast, seems to have a more standard inflation problem with price pressures across a wider set of items that still need to be contained. This leaves the Bank of England with a harder job to do to bring inflation under control. </p>
<p>And so, we can expect inflation to keep slowing in the eurozone and the US without much intervention. In the UK, however, further action might be needed if the Bank of England is to keep price rises under control.</p><img src="https://counter.theconversation.com/content/218561/count.gif" alt="The Conversation" width="1" height="1" />
<p class="fine-print"><em><span>The authors do not work for, consult, own shares in or receive funding from any company or organisation that would benefit from this article, and have disclosed no relevant affiliations beyond their academic appointment.</span></em></p>The UK, eurozone and US inflation stories have diverged, which means each economy is now fighting a distinct battle with prices rises, which could require very different weapons.Pietro Galeone, Research fellow, Bocconi UniversityDaniel Gros, Professor of Practice and Director of the Institute for European Policymaking, Bocconi UniversityLicensed as Creative Commons – attribution, no derivatives.tag:theconversation.com,2011:article/2182252023-11-21T10:08:58Z2023-11-21T10:08:58ZWhy further RBA rate hikes are less likely now than even 1 week ago<figure><img src="https://images.theconversation.com/files/560651/original/file-20231121-19-d1cauc.png?ixlib=rb-1.1.0&rect=878%2C761%2C2660%2C1388&q=45&auto=format&w=496&fit=clip" /><figcaption><span class="caption">
</span> <span class="attribution"><span class="source">Shutterstock</span></span></figcaption></figure><p>Since Australia’s Reserve Bank hiked interest rates two weeks ago, there have been two important developments – one in the United States and the other in the United Kingdom.</p>
<p>If it’s not clear to you why events overseas influence Australia’s interest rates, which are meant to be set to control Australian inflation, read on.</p>
<h2>US and UK inflation close to zero</h2>
<p>We haven’t been complete masters of our own destiny since the Australian dollar was floated <a href="https://www.smh.com.au/business/inside-the-floating-of-the-a-20131211-2z6ic.html">40 years ago next month</a>.</p>
<p>What happened in the US last Tuesday was news of dramatically lower US inflation. When increases and decreases in prices were taken together, overall US prices moved not at all in the month of October. That’s right, inflation was <a href="https://www.bls.gov/news.release/cpi.nr0.htm">zero</a>.</p>
<p>While zero movement in one month doesn’t mean zero over the entire year, it helps bring down the rate over the entire year. US inflation fell from 3.7% in the year to September to <a href="https://www.bls.gov/news.release/cpi.nr0.htm">3.2%</a> in the month to October.</p>
<p>Then the next day we got similar news from the UK. </p>
<p>Taken together, prices in the United Kingdom scarcely grew at all in October, climbing just <a href="https://www.ons.gov.uk/economy/inflationandpriceindices/bulletins/consumerpriceinflation/october2023">0.1%</a>. The screeching halt to UK monthly inflation took the annual rate down from 6.7% for the year to September to <a href="https://www.ons.gov.uk/economy/inflationandpriceindices/bulletins/consumerpriceinflation/october2023">4.6%</a> for the year to October.</p>
<hr>
<p><iframe id="olocQ" class="tc-infographic-datawrapper" src="https://datawrapper.dwcdn.net/olocQ/3/" height="400px" width="100%" style="border: none" frameborder="0"></iframe></p>
<hr>
<p>In both the <a href="https://www.smh.com.au/business/the-economy/mission-accomplished-fed-s-inflation-success-raises-hopes-for-rba-20231115-p5ek2k.html">US</a> and the <a href="https://www.reuters.com/markets/rates-bonds/bank-englands-pill-says-central-bank-may-be-able-reconsider-rates-stance-next-2023-11-06/">UK</a>, there’s talk there will be no need for further interest rate hikes, and very probably a case for interest rate cuts as soon as next year.</p>
<p>We don’t yet know what happened to Australia’s inflation rate in October – the Bureau of Statistics will tell us next week.</p>
<p>But we have an early indication.</p>
<p>The Melbourne Institute inflation gauge, which roughly tracks the bureau’s measure, <a href="https://tradingeconomics.com/australia/mi-inflation-gauge-mom">fell 0.1%</a> in October. If that is what the bureau finds – that overall prices barely moved (or fell) in October – Australia’s annual inflation rate should fall from 5.6% for the year to September to around 5.2% for the year to October. </p>
<h2>Inflation down all over</h2>
<p>All over the world, inflation is falling for much the same set of reasons: the price of oil is heading back down after Saudi Arabia and Russia tried to <a href="https://www.bbc.com/news/business-65804768">restrict supply</a> in the middle of the year, and the price pressures caused by shortages are easing.</p>
<p>As Australia’s Reserve Bank conceded in the <a href="https://www.rba.gov.au/monetary-policy/rba-board-minutes/2023/2023-11-07.html">minutes</a> of the November board meeting, in which it pushed up rates, there has been “an easing in supply chain pressures and raw materials prices”.</p>
<p>Not that this means the bank is relaxed about what’s happening to inflation; far from it.</p>
<p>In the minutes released on Tuesday and in <a href="https://rba.livecrowdevents.tv/MicheleBullockGovernorattheASICAnnualForum21nov/stream">remarks delivered at a conference</a> ahead of their release, Governor Michele Bullock said what concerned her was stronger-than-expected <a href="https://www.rba.gov.au/monetary-policy/rba-board-minutes/2023/2023-11-07.html">demand pressures</a>. Australians remained keen to spend.</p>
<p>And she drew attention to disturbing</p>
<blockquote>
<p>growing signs of a mindset among businesses that any cost increases could be passed onto consumers </p>
</blockquote>
<p>But what has just happened overseas will help, big time. Here’s why.</p>
<h2>Australians’ buying power just jumped</h2>
<p>As soon as the news of low US inflation came out last Tuesday, the US dollar <a href="https://www.reuters.com/markets/currencies/yens-slide-multi-decade-lows-keeps-markets-intervention-alert-2023-11-14">slid</a>. </p>
<p>Investors became less keen to hold US dollars when it became less likely that US interest rates would rise further, and a good deal more likely they would fall.</p>
<p>Against the Australian dollar, the US dollar fell 2%. From an Australian’s point of view, the buying power of an Australian dollar jumped from 63.7 to 64.9 US cents and has since jumped to 65.8 US cents. </p>
<hr>
<p><strong>A sudden jump in the value of the Australian dollar</strong></p>
<hr>
<p>This means that, for as long as it lasts, Australian dollars will buy more than they did. </p>
<p>Australians will pay less in Australian dollars for the goods and services ultimately paid for with US dollars. The changed interest rate outlook in the US will act to keep Australian prices low.</p>
<p>In this way, decisions made in the US not to increase interest rates or even to cut them make it easier for Australia’s Reserve Bank not to increase rates – or even to cut them.</p>
<h2>A higher dollar means lower inflation</h2>
<p>The effect isn’t big. The RBA believes it takes a 10% change in the value of the Australian dollar to move the Australian
inflation rate <a href="https://www.afr.com/markets/debt-markets/diverging-rate-outlook-turbocharges-a-as-us-inflation-eases-20231115-p5ek13">0.4 percentage points</a>.</p>
<p>But it is better than things moving in the other direction, which is what has been happening until now. </p>
<p>For more than a year now, whenever interest rates have climbed in the US, Australia’s Reserve Bank has been under pressure to push up its rates to stop the Australian dollar falling and prices climbing.</p>
<p>No longer. After last week’s news from the US and the UK, Australian financial markets began pricing in a <a href="https://www.asx.com.au/markets/trade-our-derivatives-market/futures-market/rba-rate-tracker">close to zero</a> chance of further interest rate rises – with a fair chance of a rate cut next year.</p>
<hr>
<p>
<em>
<strong>
Read more:
<a href="https://theconversation.com/why-its-a-good-bet-the-melbourne-cup-day-rate-hike-will-be-the-last-217094">Why it's a good bet the Melbourne Cup Day rate hike will be the last</a>
</strong>
</em>
</p>
<hr>
<p>It’s always impossible to tell for sure what the Reserve Bank will do to rates. A lot will depend on what actually happens to inflation. </p>
<p>But for the first time in a long time, the Reserve Bank has tail winds from overseas, rather than headwinds.</p>
<p>For the first time in a long time, the bank won’t feel pressured to push up rates just because rates have been pushed up overseas.</p><img src="https://counter.theconversation.com/content/218225/count.gif" alt="The Conversation" width="1" height="1" />
<p class="fine-print"><em><span>Peter Martin is Economics Editor of The Conversation. </span></em></p>Australian financial markets are now pointing to a close to zero chance of further rate rises – with a fair chance of a rate cut next year. That’s thanks to the latest news from the US and UK.Peter Martin, Visiting Fellow, Crawford School of Public Policy, Australian National UniversityLicensed as Creative Commons – attribution, no derivatives.tag:theconversation.com,2011:article/2180552023-11-17T17:18:24Z2023-11-17T17:18:24ZPrice inflation is slowing, but here’s why it still feels like we’re in a cost of living crisis<figure><img src="https://images.theconversation.com/files/560166/original/file-20231117-21-ysib4m.jpg?ixlib=rb-1.1.0&rect=36%2C60%2C7969%2C5281&q=45&auto=format&w=496&fit=clip" /><figcaption><span class="caption">
</span> <span class="attribution"><a class="source" href="https://www.shutterstock.com/image-photo/woman-gloves-hot-drink-bill-trying-2212717461">Daisy Daisy/Shutterstock</a></span></figcaption></figure><p>The latest UK consumer price index (CPI) data has been <a href="https://twitter.com/RishiSunak/status/1724711277996503057">hailed as a win</a> for prime minister Rishi Sunak’s aim to half inflation, announced earlier this year. Prices <a href="https://www.ons.gov.uk/economy/inflationandpriceindices/bulletins/consumerpriceinflation/october2023">rose by 4.6%</a> in October 2023, bringing the rate of price growth down to its lowest point since an October 2022 peak of <a href="https://www.ons.gov.uk/economy/inflationandpriceindices/bulletins/consumerpriceinflation/october2023">11.1%</a>. </p>
<p>But inflation coming down gradually does not mean prices are falling – they are merely increasing at a slower pace. Prices remain high, deepening the cost of living crisis for many, especially those whose nominal wages have not increased at pace with inflation in recent years. </p>
<p>Compounding this, <a href="https://www.ons.gov.uk/economy/inflationandpriceindices/articles/cpihconsistentinflationrateestimatesforukhouseholdgroups20052017/novembertodecember2022">poor households spend</a> a bigger proportion of their income on food, energy, and rent – three costs that have spiked the most in recent years, and still remain high.</p>
<p>A decline in energy prices was the biggest contributor to the recent inflation slowdown. But even though electricity, gas and other fuel costs have fallen by <a href="https://www.ons.gov.uk/economy/inflationandpriceindices/bulletins/consumerpriceinflation/october2023">21.7%</a> since October 2022, these prices remain very high. </p>
<p>Gas prices are about <a href="https://www.ons.gov.uk/economy/inflationandpriceindices/bulletins/consumerpriceinflation/october2023">60%</a> higher than they were in October 2021 and the price of electricity is about <a href="https://www.ons.gov.uk/economy/inflationandpriceindices/bulletins/consumerpriceinflation/october2023">40%</a> higher. Compared to January 2021, electricity, gas and other fuel costs are currently 82% higher.</p>
<p>Annual inflation in the price of food and non-alcoholic beverages is also still high at <a href="https://www.ons.gov.uk/economy/inflationandpriceindices/bulletins/consumerpriceinflation/october2023">10.1%</a>. October 2023 food prices were around <a href="https://www.ons.gov.uk/economy/inflationandpriceindices/bulletins/consumerpriceinflation/october2023">30%</a> higher than in October 2021, while private rents are up by <a href="https://www.ons.gov.uk/economy/inflationandpriceindices/bulletins/indexofprivatehousingrentalprices/previousReleases">11.5%</a> compared to January 2021.</p>
<p>The government’s <a href="https://news.sky.com/story/more-than-a-million-work-days-lost-to-strike-action-in-2022-12775946">fears of a wage-price spiral</a> – its reasoning for holding out against public sector strikes for so long – have also failed to materialise. </p>
<p>An adequate increase in public sector pay in health, education and the civil service would have reversed decades of below-inflation pay for these workers. And public sector wages do not directly lead to rising input costs for private companies, and so would have done little to fuel a wage-price spiral.</p>
<hr>
<p>
<em>
<strong>
Read more:
<a href="https://theconversation.com/strikes-why-refusing-public-sector-pay-rises-wont-help-reduce-inflation-198333">Strikes: why refusing public sector pay rises won't help reduce inflation</a>
</strong>
</em>
</p>
<hr>
<p>Recent wage disputes and high job vacancy rates have delivered only <a href="https://www.ons.gov.uk/employmentandlabourmarket/peopleinwork/earningsandworkinghours/datasets/averageweeklyearningsearn01">modest increases in real pay</a> in the public sector (1.4%). Wages have stagnated in manufacturing and wholesaling, retailing, hotels and restaurants sectors, and fallen in construction (by 2.8%) as of September 2023 compared to September 2022. </p>
<p>The only sectors that saw a substantial real pay rise are finance and business services (2%) and transport and storage (15.8%). In fact, real wages remain below pre-pandemic levels in all other sectors.</p>
<p><strong>Wages are stagnant or falling in some sectors:</strong></p>
<figure class="align-center zoomable">
<a href="https://images.theconversation.com/files/560162/original/file-20231117-17-9l9t8x.png?ixlib=rb-1.1.0&q=45&auto=format&w=1000&fit=clip"><img alt="Line graph showing changes to weekly earnings, as described in the article." src="https://images.theconversation.com/files/560162/original/file-20231117-17-9l9t8x.png?ixlib=rb-1.1.0&q=45&auto=format&w=754&fit=clip" srcset="https://images.theconversation.com/files/560162/original/file-20231117-17-9l9t8x.png?ixlib=rb-1.1.0&q=45&auto=format&w=600&h=401&fit=crop&dpr=1 600w, https://images.theconversation.com/files/560162/original/file-20231117-17-9l9t8x.png?ixlib=rb-1.1.0&q=30&auto=format&w=600&h=401&fit=crop&dpr=2 1200w, https://images.theconversation.com/files/560162/original/file-20231117-17-9l9t8x.png?ixlib=rb-1.1.0&q=15&auto=format&w=600&h=401&fit=crop&dpr=3 1800w, https://images.theconversation.com/files/560162/original/file-20231117-17-9l9t8x.png?ixlib=rb-1.1.0&q=45&auto=format&w=754&h=504&fit=crop&dpr=1 754w, https://images.theconversation.com/files/560162/original/file-20231117-17-9l9t8x.png?ixlib=rb-1.1.0&q=30&auto=format&w=754&h=504&fit=crop&dpr=2 1508w, https://images.theconversation.com/files/560162/original/file-20231117-17-9l9t8x.png?ixlib=rb-1.1.0&q=15&auto=format&w=754&h=504&fit=crop&dpr=3 2262w" sizes="(min-width: 1466px) 754px, (max-width: 599px) 100vw, (min-width: 600px) 600px, 237px"></a>
<figcaption>
<span class="caption">Real average weekly earnings (total pay including bonuses and arears, seasonally adjusted, deflated using CPIH in constant 2015 prices).</span>
<span class="attribution"><a class="source" href="https://www.ons.gov.uk/employmentandlabourmarket/peopleinwork/earningsandworkinghours/datasets/averageweeklyearningsearn01">Author provided using Office for National Statistics data.</a>, <a class="license" href="http://creativecommons.org/licenses/by-nc-nd/4.0/">CC BY-NC-ND</a></span>
</figcaption>
</figure>
<h2>Boosting profits</h2>
<p>Meanwhile, some firms have added the rising costs of inputs like energy and food into the price of the goods they sell, squeezing the poorly-paid from the other side. Some have even increased their profit margins <a href="https://www.ippr.org/research/publications/prices-and-profits-after-the-pandemic">since 2021</a> by raising prices at a faster rate than the increase in their input costs. </p>
<p>A <a href="https://bankunderground.co.uk/2023/09/07/profit-margins-and-firm-price-growth-evidence-from-the-decision-maker-panel/">Bank of England survey</a> shows many of the firms with the highest profit margins are expected to increase their profit margins further in 2023, while firms with the lowest profit margins reported a drop in 2022, and are only expected to see a partial recovery this year. </p>
<p>Wages could increase without causing higher inflation if the top firms cut their profit margins. This would also help the firms who were not able to pass on high input, wages or borrowing costs to their customers. With <a href="https://www.gov.uk/government/statistics/monthly-insolvency-statistics-october-2023">company insolvencies at a 14-year high</a>, they are instead cutting back non-essential spending.</p>
<p>But the government has done little to address the rise in profit margins for the top companies beyond a limited energy price cap and windfall taxes on energy companies. As food prices soared, government intervention <a href="https://www.theguardian.com/politics/2023/may/16/farmers-dismiss-sunaks-farm-to-fork-summit-as-an-empty-meeting">amounted to meetings</a> with the farmers, food producers and some of Britain’s largest supermarkets to discuss capping price increases in 2023 without actual price controls.</p>
<hr>
<p>
<em>
<strong>
Read more:
<a href="https://theconversation.com/six-ways-the-upcoming-autumn-statement-could-affect-your-personal-finances-217854">Six ways the upcoming autumn statement could affect your personal finances</a>
</strong>
</em>
</p>
<hr>
<p>Chancellor Jeremy Hunt’s upcoming autumn statement is unlikely to offer many solid solutions to tackle the cost of living crisis or problems with public physical and social infrastructure. Hunt is expected to stick to the narrative that a reduction in public debt/GDP is essential to fight inflation. </p>
<p>Similarly, the Bank of England may hold interest rates again at its next Monetary Policy Committee meeting in December, despite stagnation in <a href="https://www.theguardian.com/business/2023/nov/17/fall-in-retail-sales-in-great-britain-signals-high-street-recession">consumer demand</a> and <a href="https://www.theguardian.com/business/live/2023/sep/25/uk-economy-slowdown-renewed-signs-of-stress-ftse-stock-market-pound-business-live?filterKeyEvents=false&page=with:block-65111dda8f087d5106a1286b#block-65111dda8f087d5106a1286b">business investment</a>. </p>
<p>These policies will not help to address the multiple intersecting crises facing the UK right now, including inequalities in class, gender and race, ecological breakdown, geopolitical turmoil and technological change – not to mention the ongoing cost of living crisis.</p><img src="https://counter.theconversation.com/content/218055/count.gif" alt="The Conversation" width="1" height="1" />
<p class="fine-print"><em><span>Özlem Onaran received funding from ESRC Rebuilding Macroeconomics, International Trade Union Confederation, Women’s Budget Group, American University, the Institute for New Economic Thinking, the Foundation of European Progressive Studies, the Vienna Chamber of Labour, and Unions21.</span></em></p>Prices remain high and there is much more the government could do to help people.Özlem Onaran, Professor of Economics, University of GreenwichLicensed as Creative Commons – attribution, no derivatives.tag:theconversation.com,2011:article/2166532023-10-31T12:56:38Z2023-10-31T12:56:38ZInterest rates: if central banks don’t start cutting them soon, it could actually increase inflation<figure><img src="https://images.theconversation.com/files/556622/original/file-20231030-15-ssa8rd.jpeg?ixlib=rb-1.1.0&q=45&auto=format&w=496&fit=clip" /><figcaption><span class="caption">Another reason to be fearful. </span> <span class="attribution"><a class="source" href="https://www.shutterstock.com/image-photo/businessman-walking-on-abstract-growing-interest-2126771846">Golden Dayz</a></span></figcaption></figure><p>What next for interest rates? The Bank of England’s Monetary Policy Committee (MPC) is <a href="https://www.ft.com/content/2b0dcf95-b4ee-4eee-ad39-a7f5f3fbed3e">widely expected</a> to leave them unchanged when it meets on November 2, despite the fact that UK headline inflation is still at 6.7%. If so, it will mark the second monthly freeze in a row, following 14 consecutive hikes dating back to late 2021. </p>
<p>The main argument for pausing when inflation is still high is that each rise takes time to have full effect. It’s possible that the brakes have already been pressed far enough, and that any <a href="https://www.schroders.com/en-gb/uk/institutional/insights/uk-should-brace-for-6-5-interest-rates-here-s-why-we-ve-raised-our-forecast/">further rate rise</a> could push the economy into recession. The MPC <a href="https://www.bankofengland.co.uk/monetary-policy-summary-and-minutes/2023/september-2023">said as much</a> in its rationale for the September hold. </p>
<p>While higher interest rates subdue inflationary pressure by reducing the amounts that people borrow and spend, households and businesses don’t feel the effect immediately. This is because they have either not borrowed or fixed their interest rates at a lower level. When those fixed-rate periods end, these borrowers will join the many who must already channel more of their income into interest payments, leaving less to buy other things.</p>
<p>The <a href="https://www.ons.gov.uk/peoplepopulationandcommunity/housing/articles/howincreasesinhousingcostsimpacthouseholds/2023-01-09">Bank of England (BoE) estimated</a> in January that more than 1.4 million out of the <a href="https://www.ukfinance.org.uk/news-and-insight/press-release/uk-finance-mortgage-data#:%7E:text=There%20are%20a%20total%20of,if%20the%20Bank%20Rate%20rises.&text=There%20are%20a%20total%20of%202%2C033%2C512%20buy%20to%20let%20mortgages,also%20being%20on%20fixed%20rates.">total of 8.5 million</a> mortgage borrowers in the UK would see interest rates jump during 2023, as they move off fixed rates that were mostly below 2%. Another 1.6 million <a href="https://www.theguardian.com/money/2023/jun/17/uk-homeowners-face-huge-rise-in-payments-when-fixed-rate-mortgages-expire#:%7E:text=In%20total%2C%20up%20to%204.4,and%20the%20end%20of%202024.">are also expected</a> to have to remortgage in 2024. Meanwhile, even debt-free businesses will find their income reduced as customers who need credit find it’s costing them more.</p>
<h2>Alternative arguments</h2>
<p>Additional pressures to avoid any further interest rate rises are now evident. <a href="https://www.levyinstitute.org/publications/in-defense-of-low-interest-rates">Some economists doubt</a> that raising rates has had much effect against <a href="https://theconversation.com/inflation-raising-interest-rates-was-never-the-right-medicine-heres-why-central-bankers-did-it-anyway-216087">today’s inflation</a> because it has largely been caused, not by an overheating economy, but by scarcity of goods and commodities due to the Ukraine war and opening up after the pandemic. </p>
<p>Still others point to evidence that rises in interest rates are followed by <em>higher</em> inflation. This has been found in <a href="https://www.nber.org/system/files/working_papers/w23977/w23977.pdf">recent studies</a> of the US and Japan, and some lower-income economies such as <a href="https://intapi.sciendo.com/pdf/10.2478/jcbtp-2018-0019">Brazil and Indonesia</a>. To understand this, you need to grasp a standard economic theory called the “<a href="https://papers.ssrn.com/sol3/papers.cfm?abstract_id=3349096">Fisher effect</a>”, named after an early 20th century American economist called <a href="https://en.wikipedia.org/wiki/Irving_Fisher">Irvine Fisher</a>. It suggests that economies have an equilibrium “real” interest rate, measured by the interest rate minus inflation.</p>
<p>For example, if a high-street bank offers one-year loans at 5% and annual inflation jumps from 3% to 5%, the bank has less incentive to lend at the same rate because the amount it gets back at the end of the year will be worth less than before. For the same reason, households and firms are dissuaded from saving. They are reacting to the fact that “real” interest rates have fallen. To keep lending and saving on track – in other words, to keep the economy running as normal – the central bank must raise the headline interest rate. </p>
<p><strong>UK interest rate vs inflation</strong></p>
<figure class="align-center zoomable">
<a href="https://images.theconversation.com/files/556624/original/file-20231030-17-iur9lv.png?ixlib=rb-1.1.0&q=45&auto=format&w=1000&fit=clip"><img alt="Graph showing 25 years of inflation and interest rates in the UK" src="https://images.theconversation.com/files/556624/original/file-20231030-17-iur9lv.png?ixlib=rb-1.1.0&q=45&auto=format&w=754&fit=clip" srcset="https://images.theconversation.com/files/556624/original/file-20231030-17-iur9lv.png?ixlib=rb-1.1.0&q=45&auto=format&w=600&h=350&fit=crop&dpr=1 600w, https://images.theconversation.com/files/556624/original/file-20231030-17-iur9lv.png?ixlib=rb-1.1.0&q=30&auto=format&w=600&h=350&fit=crop&dpr=2 1200w, https://images.theconversation.com/files/556624/original/file-20231030-17-iur9lv.png?ixlib=rb-1.1.0&q=15&auto=format&w=600&h=350&fit=crop&dpr=3 1800w, https://images.theconversation.com/files/556624/original/file-20231030-17-iur9lv.png?ixlib=rb-1.1.0&q=45&auto=format&w=754&h=440&fit=crop&dpr=1 754w, https://images.theconversation.com/files/556624/original/file-20231030-17-iur9lv.png?ixlib=rb-1.1.0&q=30&auto=format&w=754&h=440&fit=crop&dpr=2 1508w, https://images.theconversation.com/files/556624/original/file-20231030-17-iur9lv.png?ixlib=rb-1.1.0&q=15&auto=format&w=754&h=440&fit=crop&dpr=3 2262w" sizes="(min-width: 1466px) 754px, (max-width: 599px) 100vw, (min-width: 600px) 600px, 237px"></a>
<figcaption>
<span class="caption">Inflation (orange) is consumer price inflation. Interest rates (blue) are the Bank of England benchmark rate.</span>
<span class="attribution"><a class="source" href="https://www.tradingview.com/symbols/SPX/?exchange=SP">Trading View</a></span>
</figcaption>
</figure>
<p>Some of this <a href="https://www.stlouisfed.org/publications/regional-economist/july-2016/neo-fisherism-a-radical-idea-or-the-most-obvious-solution-to-the-low-inflation-problem#fig1">research also suggests</a> there is a two-way causation. Not only do interest rates need to rise in response to inflation, they can also pull inflation upwards – precisely the opposite of what the monetary policymakers intend. This becomes a risk when interest rates are expected to stay high. Businesses then push up their prices, and households raise their wage demands, to cover their increased borrowing costs, and the expectation is fulfilled as central banks are forced to keep rates high. </p>
<p>Rate rises can still be effective if they reduce inflation quickly, allowing them to fall back to previous levels before expectations change. The International Monetary Fund, which often represents the economic mainstream, has <a href="https://www.imf.org/en/Blogs/Articles/2023/04/10/interest-rates-likely-to-return-towards-pre-pandemic-levels-when-inflation-is-tamed">conveyed the view</a> that global interest rates will drop back to pre-pandemic levels once the present inflation wave has passed.</p>
<p>But other experts, including the Bank of England’s chief economist, <a href="https://www.reuters.com/world/uk/boe-will-see-job-through-inflation-pill-says-2023-08-31/">Huw Pill</a>, believe interest rates must stay elevated for a longer time to ensure inflation is crushed. Some even argue that they should now stabilise close to present levels, as a reset from the exceptional 13 years in which they stayed close to zero after the global financial crisis of 2007-09. </p>
<p><strong>UK real interest rates 2000-22</strong></p>
<figure class="align-center zoomable">
<a href="https://images.theconversation.com/files/557268/original/file-20231102-23-fzu1md.png?ixlib=rb-1.1.0&q=45&auto=format&w=1000&fit=clip"><img alt="Chart showing real interest rates since 2000" src="https://images.theconversation.com/files/557268/original/file-20231102-23-fzu1md.png?ixlib=rb-1.1.0&q=45&auto=format&w=754&fit=clip" srcset="https://images.theconversation.com/files/557268/original/file-20231102-23-fzu1md.png?ixlib=rb-1.1.0&q=45&auto=format&w=600&h=300&fit=crop&dpr=1 600w, https://images.theconversation.com/files/557268/original/file-20231102-23-fzu1md.png?ixlib=rb-1.1.0&q=30&auto=format&w=600&h=300&fit=crop&dpr=2 1200w, https://images.theconversation.com/files/557268/original/file-20231102-23-fzu1md.png?ixlib=rb-1.1.0&q=15&auto=format&w=600&h=300&fit=crop&dpr=3 1800w, https://images.theconversation.com/files/557268/original/file-20231102-23-fzu1md.png?ixlib=rb-1.1.0&q=45&auto=format&w=754&h=377&fit=crop&dpr=1 754w, https://images.theconversation.com/files/557268/original/file-20231102-23-fzu1md.png?ixlib=rb-1.1.0&q=30&auto=format&w=754&h=377&fit=crop&dpr=2 1508w, https://images.theconversation.com/files/557268/original/file-20231102-23-fzu1md.png?ixlib=rb-1.1.0&q=15&auto=format&w=754&h=377&fit=crop&dpr=3 2262w" sizes="(min-width: 1466px) 754px, (max-width: 599px) 100vw, (min-width: 600px) 600px, 237px"></a>
<figcaption>
<span class="caption"></span>
<span class="attribution"><a class="source" href="https://www.bankofengland.co.uk/boeapps/database/Bank-Rate.asp">BoE/ONS</a></span>
</figcaption>
</figure>
<p><a href="https://www.jrf.org.uk/press/interest-rate-hike-will-have-serious-consequences-low-income-families">The risks</a> of keeping interest rates at their present high level extend further than the possibility of causing recession, and worsening misery for the poorest borrowers, without taming inflation. A rise in interest rates means <a href="https://knowablemagazine.org/article/society/2022/the-obscure-calculation-transforming-climate-policy">investors become</a> more short-termist – increasing their focus on immediate costs and putting less value on potential gains further into the future. Especially when we need many billions of dollars of investment to build the green economy, a shortfall caused by high interest rates could have ramifications for the future of the planet.</p>
<p>Besides that concern, production capacity will only grow slowly across the board if investment is choked off. That is likely to be another source of inflationary pressure, if central banks don’t start to reverse the rise in interest rates early next year.</p><img src="https://counter.theconversation.com/content/216653/count.gif" alt="The Conversation" width="1" height="1" />
<p class="fine-print"><em><span>Alan Shipman does not work for, consult, own shares in or receive funding from any company or organisation that would benefit from this article, and has disclosed no relevant affiliations beyond their academic appointment.</span></em></p>So you thought raising interest rates brought down inflation? The reality is a bit more debatable.Alan Shipman, Senior Lecturer in Economics, The Open UniversityLicensed as Creative Commons – attribution, no derivatives.tag:theconversation.com,2011:article/2160872023-10-20T15:24:18Z2023-10-20T15:24:18ZInflation: raising interest rates was never the right medicine – here’s why central bankers did it anyway<figure><img src="https://images.theconversation.com/files/555021/original/file-20231020-17-7s9i1o.jpg?ixlib=rb-1.1.0&q=45&auto=format&w=496&fit=clip" /><figcaption><span class="caption">Pain, no gain? Bank of England Governor Andrew Bailey. </span> <span class="attribution"><a class="source" href="https://www.flickr.com/photos/imfphoto/51589159888/in/photolist-2nwx1ky-2nSrKcw-2nwrLSq-2nSuk8H-2nSwZQq-E2Ve9H-2nSwZRH-2nSrKbu-2nSwFWg-2nSrKjq-2mAKVTW-2k5RZiM-2j6RVqc-2j6Tovo-E2Yqn8-2ngymcQ-ac1Rk-2mAJPT9-2oLaMFA-isobr-2oKXTVq-2oLdiw5-7itq9N-2oL5EJU-2oL5g73-2oL4CcG-2oLagKW-2oLaF8Y-2oLaFam-2oL8f4E-2oLadqz-2oL9ySC-2oL5g8A-2oL6Sve-7ipwbM-2oKWMsg-9JspXi-2oti5Eo-2oti5Dw-isnVx-2noQWwH-isnFy-2noYNVY-7ipwoH-2noYNZa-2noXsQD-2noYNJR-2p8PNcg-2p8Sm3F-2noYNRp">IMF</a>, <a class="license" href="http://creativecommons.org/licenses/by-sa/4.0/">CC BY-SA</a></span></figcaption></figure><p>Inflation remains too high in the UK. The annual rate of consumer price inflation to <a href="https://www.ons.gov.uk/economy/inflationandpriceindices/bulletins/consumerpriceinflation/september2023#:%7E:text=a%20year%20ago.-,The%20Consumer%20Prices%20Index%20(CPI)%20rose%20by%206.7%25%20in,of%2011.1%25%20in%20October%202022.">September was 6.7%</a>, the same as a month earlier. This is well below the 11.1% peak reached in October 2022, but the failure of inflation to keep falling indicates it is proving far more stubborn than anticipated. </p>
<p>This may prompt the Bank of England’s Monetary Policy Committee (MPC) to raise the benchmark interest rate yet again when it meets in November, but in my view this would not be entirely justified. </p>
<p>In reality, the rate hikes that began two years ago have not been very helpful in tackling inflation, at least not directly. So what’s the problem and is there a better alternative?</p>
<h2>Right policy, wrong inflation</h2>
<p>Raising interest rates is the MPC’s main tool for trying to get inflation back to its target rate of 2%. The idea is that this makes it more expensive to borrow money, which should reduce consumer demand for goods and services. </p>
<p>The trouble is that the type of inflation recently witnessed in the UK seems less a problem of excessive demand than because costs have been rising for manufacturers and service providers. It’s known as “cost-push inflation” as opposed to “demand-pull inflation”. </p>
<p><strong>Inflation rates (UK, US, eurozone)</strong></p>
<figure class="align-center zoomable">
<a href="https://images.theconversation.com/files/554994/original/file-20231020-19-hx5koj.png?ixlib=rb-1.1.0&q=45&auto=format&w=1000&fit=clip"><img alt="Graph comparing inflation rates of UK, US and eurozone" src="https://images.theconversation.com/files/554994/original/file-20231020-19-hx5koj.png?ixlib=rb-1.1.0&q=45&auto=format&w=754&fit=clip" srcset="https://images.theconversation.com/files/554994/original/file-20231020-19-hx5koj.png?ixlib=rb-1.1.0&q=45&auto=format&w=600&h=353&fit=crop&dpr=1 600w, https://images.theconversation.com/files/554994/original/file-20231020-19-hx5koj.png?ixlib=rb-1.1.0&q=30&auto=format&w=600&h=353&fit=crop&dpr=2 1200w, https://images.theconversation.com/files/554994/original/file-20231020-19-hx5koj.png?ixlib=rb-1.1.0&q=15&auto=format&w=600&h=353&fit=crop&dpr=3 1800w, https://images.theconversation.com/files/554994/original/file-20231020-19-hx5koj.png?ixlib=rb-1.1.0&q=45&auto=format&w=754&h=443&fit=crop&dpr=1 754w, https://images.theconversation.com/files/554994/original/file-20231020-19-hx5koj.png?ixlib=rb-1.1.0&q=30&auto=format&w=754&h=443&fit=crop&dpr=2 1508w, https://images.theconversation.com/files/554994/original/file-20231020-19-hx5koj.png?ixlib=rb-1.1.0&q=15&auto=format&w=754&h=443&fit=crop&dpr=3 2262w" sizes="(min-width: 1466px) 754px, (max-width: 599px) 100vw, (min-width: 600px) 600px, 237px"></a>
<figcaption>
<span class="caption">UK = dark blue; eurozone = turquoise; US = orange.</span>
<span class="attribution"><a class="source" href="https://www.tradingview.com/symbols/SPX/?exchange=SP">Trading View</a></span>
</figcaption>
</figure>
<p>Production costs have risen for several reasons. During the COVID-19 pandemic, central banks “created money” through <a href="https://www.bankofengland.co.uk/monetary-policy/quantitative-easing">quantitative easing</a> to enable their governments to run large spending deficits to pay for furloughs and other interventions to help citizens through the crisis. </p>
<p>When countries started reopening, it meant <a href="https://www.ons.gov.uk/economy/grossdomesticproductgdp/timeseries/mwb7/ukea">people had money</a> in their pockets to buy more goods and services. Yet with China still in lockdown, global supply chains could not keep pace with the resurgent demand so prices went up – <a href="https://tradingeconomics.com/commodity/crude-oil">most notably oil</a>. </p>
<p><strong>Oil price (Brent crude, US$)</strong></p>
<figure class="align-center zoomable">
<a href="https://images.theconversation.com/files/554996/original/file-20231020-27-o0dvnq.png?ixlib=rb-1.1.0&q=45&auto=format&w=1000&fit=clip"><img alt="Chart showing price of Brent crude oil" src="https://images.theconversation.com/files/554996/original/file-20231020-27-o0dvnq.png?ixlib=rb-1.1.0&q=45&auto=format&w=754&fit=clip" srcset="https://images.theconversation.com/files/554996/original/file-20231020-27-o0dvnq.png?ixlib=rb-1.1.0&q=45&auto=format&w=600&h=346&fit=crop&dpr=1 600w, https://images.theconversation.com/files/554996/original/file-20231020-27-o0dvnq.png?ixlib=rb-1.1.0&q=30&auto=format&w=600&h=346&fit=crop&dpr=2 1200w, https://images.theconversation.com/files/554996/original/file-20231020-27-o0dvnq.png?ixlib=rb-1.1.0&q=15&auto=format&w=600&h=346&fit=crop&dpr=3 1800w, https://images.theconversation.com/files/554996/original/file-20231020-27-o0dvnq.png?ixlib=rb-1.1.0&q=45&auto=format&w=754&h=435&fit=crop&dpr=1 754w, https://images.theconversation.com/files/554996/original/file-20231020-27-o0dvnq.png?ixlib=rb-1.1.0&q=30&auto=format&w=754&h=435&fit=crop&dpr=2 1508w, https://images.theconversation.com/files/554996/original/file-20231020-27-o0dvnq.png?ixlib=rb-1.1.0&q=15&auto=format&w=754&h=435&fit=crop&dpr=3 2262w" sizes="(min-width: 1466px) 754px, (max-width: 599px) 100vw, (min-width: 600px) 600px, 237px"></a>
<figcaption>
<span class="caption"></span>
<span class="attribution"><a class="source" href="https://www.tradingview.com/symbols/SPX/?exchange=SP">Trading View</a></span>
</figcaption>
</figure>
<p>Then came the Ukraine war, which further drove up prices of fundamental commodities, such as energy. This made inflation much worse than it would otherwise have been. You can see this reflected in consumer price inflation (CPI): it was <a href="https://www.ons.gov.uk/economy/inflationandpriceindices/bulletins/consumerpriceinflation/june2020#:%7E:text=The%20Consumer%20Prices%20Index%20(CPI)%2012%2Dmonth%20inflation%20rate,with%200.0%25%20in%20June%202019.">just 0.6%</a> in the year to June 2020, then <a href="https://www.ons.gov.uk/economy/inflationandpriceindices/bulletins/consumerpriceinflation/june2021">rose to 2.5%</a> in the year to June 2021, reflecting the supply constraints at the end of lockdown. By June 2022, four months after Russia’s invasion of Ukraine, CPI <a href="https://www.ons.gov.uk/economy/inflationandpriceindices/bulletins/consumerpriceinflation/june2022#:%7E:text=The%20Consumer%20Prices%20Index%20(CPI,of%200.5%25%20in%20June%202021.)">was 9.4%</a>.</p>
<h2>The policy problem</h2>
<p>This begs the question, why has the Bank of England (BoE) been raising rates if it’s unlikely to be effective? One answer is that other central banks have been raising rates. If the BoE doesn’t mirror rate rises in the US and eurozone, investors in the UK may move their money to these other areas because they’ll get better returns on bonds. This would see the pound depreciating against the US dollar and euro, in turn increasing import prices and aggravating inflation. </p>
<p>Part of the problem has been that the US has arguably faced more of the sort of demand-led inflation against which interest rates are effective. For one thing, the US has been less at the mercy of rising energy prices because it is <a href="https://www.eia.gov/energyexplained/us-energy-facts/imports-and-exports.php">energy self-sufficient</a>. It also didn’t lock down as uniformly as other major economies during the pandemic, so had a little more space to grow. </p>
<p>At the same time, the US has been <a href="https://tradingeconomics.com/united-states/inflation-cpi">more effective</a> at bringing down inflation than the UK, which again suggests it was fighting demand-driven price rises. In other words, the UK and other countries may to some extent have been forced to follow suit with raising interest rates to protect their currencies, not to fight inflation. </p>
<h2>What next</h2>
<p>How harmful have the rate rises been in the UK? They have not brought about a <a href="https://www.ons.gov.uk/economy/grossdomesticproductgdp/bulletins/gdpmonthlyestimateuk/august2023">recession yet</a>, but <a href="https://www.statista.com/statistics/941233/monthly-gdp-growth-uk/">growth remains</a> very weak. Lots of <a href="https://www.theguardian.com/business/2023/jun/20/cost-of-living-payments-failing-to-help-low-income-households-in-uk">people are struggling</a> with the cost of living, as well as <a href="https://www.theguardian.com/business/2023/jun/20/cost-of-living-payments-failing-to-help-low-income-households-in-uk">rent or mortgage costs</a>. Several million people are due to be hit by much higher mortgage rates as their fixed-rate deals end between now and the end of 2024. </p>
<p><strong>UK GDP growth (%)</strong></p>
<figure class="align-center zoomable">
<a href="https://images.theconversation.com/files/555000/original/file-20231020-17-596pq7.png?ixlib=rb-1.1.0&q=45&auto=format&w=1000&fit=clip"><img alt="Chart showing the annual rate of GDP growth" src="https://images.theconversation.com/files/555000/original/file-20231020-17-596pq7.png?ixlib=rb-1.1.0&q=45&auto=format&w=754&fit=clip" srcset="https://images.theconversation.com/files/555000/original/file-20231020-17-596pq7.png?ixlib=rb-1.1.0&q=45&auto=format&w=600&h=348&fit=crop&dpr=1 600w, https://images.theconversation.com/files/555000/original/file-20231020-17-596pq7.png?ixlib=rb-1.1.0&q=30&auto=format&w=600&h=348&fit=crop&dpr=2 1200w, https://images.theconversation.com/files/555000/original/file-20231020-17-596pq7.png?ixlib=rb-1.1.0&q=15&auto=format&w=600&h=348&fit=crop&dpr=3 1800w, https://images.theconversation.com/files/555000/original/file-20231020-17-596pq7.png?ixlib=rb-1.1.0&q=45&auto=format&w=754&h=437&fit=crop&dpr=1 754w, https://images.theconversation.com/files/555000/original/file-20231020-17-596pq7.png?ixlib=rb-1.1.0&q=30&auto=format&w=754&h=437&fit=crop&dpr=2 1508w, https://images.theconversation.com/files/555000/original/file-20231020-17-596pq7.png?ixlib=rb-1.1.0&q=15&auto=format&w=754&h=437&fit=crop&dpr=3 2262w" sizes="(min-width: 1466px) 754px, (max-width: 599px) 100vw, (min-width: 600px) 600px, 237px"></a>
<figcaption>
<span class="caption"></span>
<span class="attribution"><a class="source" href="https://www.tradingview.com/symbols/SPX/?exchange=SP">Trading View</a></span>
</figcaption>
</figure>
<p>If hiking interest rates is not really helping to curb inflation, it makes sense to start moving in the opposite direction before the economic situation gets any worse. To avoid any damage to the pound, the answer is for the leading central banks to coordinate their policies so that they cut rates in lockstep. </p>
<p>Unless and until this happens, there would seem to be no quick fix available. One piece of good news is that the energy price cap for typical domestic consumption <a href="https://www.ofgem.gov.uk/information-consumers/energy-advice-households/energy-price-cap">was reduced</a> from October 1 from £1,976 to £1,834 a year. That 7% reduction should lead to consumer price inflation coming down significantly towards the end of 2023. </p>
<p>More generally, the Bank of England may simply have to hope that world events move inflation in the desired direction. A key question is going to be whether the wars in Ukraine and Israel/Gaza result in further cost pressures. </p>
<p>Unfortunately there is a precedent for a Middle East conflict leading to a global economic crisis: <a href="https://en.wikipedia.org/wiki/Yom_Kippur_War">following the</a> joint assault on Israel by Syria and Egypt in 1973, Israel’s retaliation prompted petroleum cartel <a href="https://history.state.gov/milestones/1969-1976/oil-embargo#:%7E:text=During%20the%201973%20Arab%2DIsraeli,the%20post%2Dwar%20peace%20negotiations.">OPEC to impose</a> an oil embargo. This led to an <a href="https://www.macrotrends.net/1369/crude-oil-price-history-chart">almost fourfold increase</a> in the price of crude oil. </p>
<p>Since oil was fundamental to the costs of production, inflation in the UK rose to <a href="https://www.macrotrends.net/countries/GBR/united-kingdom/inflation-rate-cpi">over 16%</a> in 1974. There followed <a href="https://www.economicshelp.org/blog/780/unemployment/unemployment-rates-history/">high unemployment</a>, resulting in an unwelcome combination that economists referred to <a href="https://en.wikipedia.org/wiki/Stagflation#:%7E:text=The%20term%20stagflation%20was%20first,monetary%20policy%20in%20controlling%20inflation.">as stagflation</a>. </p>
<p>These days, <a href="https://www.imf.org/en/Blogs/Articles/2022/05/05/lower-oil-reliance-insulates-world-from-1970s-style-crude-shock">global production</a> is in fact <a href="https://ourworldindata.org/grapher/fossil-fuels-share-energy">less reliant on oil</a> as renewables have become a growing part of the energy mix. Nonetheless, an oil price hike would still drive inflation higher and weaken economic growth. So if the Middle East crisis does spiral, we may be stuck with stubborn, untreatable inflation for even longer.</p><img src="https://counter.theconversation.com/content/216087/count.gif" alt="The Conversation" width="1" height="1" />
<p class="fine-print"><em><span>Robert Gausden does not work for, consult, own shares in or receive funding from any company or organisation that would benefit from this article, and has disclosed no relevant affiliations beyond their academic appointment.</span></em></p>We need to start cutting rates, but there’s something that has to happen first.Robert Gausden, Senior Lecturer in Economics, University of PortsmouthLicensed as Creative Commons – attribution, no derivatives.tag:theconversation.com,2011:article/2151882023-10-06T13:28:15Z2023-10-06T13:28:15ZUK bonds have hit a 25-year high – here’s what that means for the economy<figure><img src="https://images.theconversation.com/files/552531/original/file-20231006-19-z1l72a.jpg?ixlib=rb-1.1.0&rect=0%2C0%2C4230%2C2811&q=45&auto=format&w=496&fit=clip" /><figcaption><span class="caption">The Bank of England (headquarters on the left) is expected to hold interest rates, causing investors to sell UK bonds.</span> <span class="attribution"><a class="source" href="https://www.shutterstock.com/image-photo/london-november-3-2016-modern-red-509977993">lazyllama/Shutterstock</a></span></figcaption></figure><p>It’s been more than a year since the UK economy was thrown into crisis after then-prime minister Liz Truss suggested making a wealth of <a href="https://theconversation.com/only-a-u-turn-by-the-government-or-the-bank-of-england-will-calm-uk-financial-markets-191523">unfunded tax cuts</a> in her September 2022 mini-budget. But a recent bond market sell-off has now sent borrowing costs rocketing again, pushing the bond market even higher than after Truss’s announcement. </p>
<p>Yields on UK treasury bonds – the rate the UK government must pay to borrow money – have risen to approximately 4.6% for ten-year bonds. Yields on 30-year bonds hit 5.1%, the highest since 1998. </p>
<p>Banks also use this rate as a key benchmark to set commercial loan rates, so this means borrowing costs are rising for businesses, as well as for the government. Two-year and five-year treasury yields (which are used to set mortgage rates) are also above the budget-fuelled high of last year, and at levels not seen in over ten years. </p>
<p><strong>UK bond yields (30 year), 1998-2023:</strong></p>
<figure class="align-center zoomable">
<a href="https://images.theconversation.com/files/552545/original/file-20231006-29-k1z29z.png?ixlib=rb-1.1.0&q=45&auto=format&w=1000&fit=clip"><img alt="Line chart showing 30-year bond yields hitting highs last seen in 1998." src="https://images.theconversation.com/files/552545/original/file-20231006-29-k1z29z.png?ixlib=rb-1.1.0&q=45&auto=format&w=754&fit=clip" srcset="https://images.theconversation.com/files/552545/original/file-20231006-29-k1z29z.png?ixlib=rb-1.1.0&q=45&auto=format&w=600&h=297&fit=crop&dpr=1 600w, https://images.theconversation.com/files/552545/original/file-20231006-29-k1z29z.png?ixlib=rb-1.1.0&q=30&auto=format&w=600&h=297&fit=crop&dpr=2 1200w, https://images.theconversation.com/files/552545/original/file-20231006-29-k1z29z.png?ixlib=rb-1.1.0&q=15&auto=format&w=600&h=297&fit=crop&dpr=3 1800w, https://images.theconversation.com/files/552545/original/file-20231006-29-k1z29z.png?ixlib=rb-1.1.0&q=45&auto=format&w=754&h=373&fit=crop&dpr=1 754w, https://images.theconversation.com/files/552545/original/file-20231006-29-k1z29z.png?ixlib=rb-1.1.0&q=30&auto=format&w=754&h=373&fit=crop&dpr=2 1508w, https://images.theconversation.com/files/552545/original/file-20231006-29-k1z29z.png?ixlib=rb-1.1.0&q=15&auto=format&w=754&h=373&fit=crop&dpr=3 2262w" sizes="(min-width: 1466px) 754px, (max-width: 599px) 100vw, (min-width: 600px) 600px, 237px"></a>
<figcaption>
<span class="caption"></span>
<span class="attribution"><a class="source" href="https://tradingeconomics.com/united-kingdom/30-year-bond-yield">Trading Economics</a>, <a class="license" href="http://creativecommons.org/licenses/by-nd/4.0/">CC BY-ND</a></span>
</figcaption>
</figure>
<p>The government issues treasury bonds at a particular interest rate that corresponds to a fixed value. Investors buy the bonds and the government uses the money to finance its spending. Since it’s a loan, the government repays the investors but also pays interest on the bond until repayment – this is the yield. </p>
<hr>
<p>
<em>
<strong>
Read more:
<a href="https://theconversation.com/how-bonds-work-and-why-everyone-is-talking-about-them-right-now-a-finance-expert-explains-191550">How bonds work and why everyone is talking about them right now: a finance expert explains</a>
</strong>
</em>
</p>
<hr>
<p>For example, a 5% bond issued for a £100 earns the investor £5 interest. If the government issues a later bond at 6% for £100 (£6 interest), the 5% (£5) bond’s value drops. This is why when bond prices fall, the yield rises and vice versa. </p>
<p>Right now, UK treasury yields are rising because investors are trying to sell UK government bonds – falling demand makes the price drop. </p>
<p>And this isn’t just happening in the UK. The same is true <a href="https://www.reuters.com/markets/global-markets-wrapup-1-2023-10-04/">around the world</a>. US bonds, for example, recently hit <a href="https://www.cnbc.com/2023/10/03/us-treasury-yields-investors-weigh-economic-outlook.html">a 16-year high</a>. </p>
<h2>Why is this happening right now?</h2>
<p>This is a tale of two central banks navigating difficult economic conditions. In September, both the Bank of England and the Federal Reserve chose not to increase their main interest rates (which are at 5.25% and 5.5% respectively). The reasons for these decisions and the position of each economy are driving the bond market changes. </p>
<p>In terms of the economy, headline inflation is currently 6.7% (6.2% for core, which strips out more volatile items like energy) <a href="https://www.ons.gov.uk/economy/inflationandpriceindices/bulletins/consumerpriceinflation/august2023">in the UK</a>, and 3.7% (4.3% core) <a href="https://www.bls.gov/news.release/cpi.nr0.htm">in the US</a>. GDP growth is at 0.6% for the UK and 2.4% for US. So, the two economies are on different tracks. </p>
<p>These figures influence financial market expectations about what central banks might do next with interest rates. The divergence in growth rates and inflation between the two economies had signalled that the banks would take different routes at their September meetings.</p>
<p>Prior to the latest decision by the Bank of England, there was <a href="https://www.schroders.com/en-gb/uk/institutional/insights/uk-should-brace-for-6-5-interest-rates-here-s-why-we-ve-raised-our-forecast/">a general view</a> that UK <a href="https://www.reuters.com/markets/rates-bonds/boe-bank-rate-peak-seen-550-strong-chance-575-2023-08-24/">rates would rise</a> to 5.5%, but a lower-than-expected inflation rate was announced days before the bank met to decide on rates and this led them to hold rates instead. After the meeting, the Bank of England also indicated that, while it expected its rate to remain at 5.25% for some time, it did not <a href="https://www.theguardian.com/business/2023/sep/21/bank-of-england-keeps-interest-rates-hold">foresee a further rise</a>. </p>
<p>In contract, while the Federal Reserve also held rates in September, this was <a href="https://www.reuters.com/markets/us/fed-leave-rates-unchanged-sept-20-cut-unlikely-before-q2-2024-2023-09-12/">seen as a pause</a> and not a stop. US rates are widely expected to rise again this year.</p>
<figure class="align-center zoomable">
<a href="https://images.theconversation.com/files/552512/original/file-20231006-19-k0slke.jpeg?ixlib=rb-1.1.0&q=45&auto=format&w=1000&fit=clip"><img alt="Chart showing that 12 of the 19 FOMC members anticipate one more 25 basis point hike this year, seven expect no change before end of 2023." src="https://images.theconversation.com/files/552512/original/file-20231006-19-k0slke.jpeg?ixlib=rb-1.1.0&q=45&auto=format&w=754&fit=clip" srcset="https://images.theconversation.com/files/552512/original/file-20231006-19-k0slke.jpeg?ixlib=rb-1.1.0&q=45&auto=format&w=600&h=600&fit=crop&dpr=1 600w, https://images.theconversation.com/files/552512/original/file-20231006-19-k0slke.jpeg?ixlib=rb-1.1.0&q=30&auto=format&w=600&h=600&fit=crop&dpr=2 1200w, https://images.theconversation.com/files/552512/original/file-20231006-19-k0slke.jpeg?ixlib=rb-1.1.0&q=15&auto=format&w=600&h=600&fit=crop&dpr=3 1800w, https://images.theconversation.com/files/552512/original/file-20231006-19-k0slke.jpeg?ixlib=rb-1.1.0&q=45&auto=format&w=754&h=754&fit=crop&dpr=1 754w, https://images.theconversation.com/files/552512/original/file-20231006-19-k0slke.jpeg?ixlib=rb-1.1.0&q=30&auto=format&w=754&h=754&fit=crop&dpr=2 1508w, https://images.theconversation.com/files/552512/original/file-20231006-19-k0slke.jpeg?ixlib=rb-1.1.0&q=15&auto=format&w=754&h=754&fit=crop&dpr=3 2262w" sizes="(min-width: 1466px) 754px, (max-width: 599px) 100vw, (min-width: 600px) 600px, 237px"></a>
<figcaption>
<span class="caption">Twelve members of the Fed’s 19-person rate-setting committee expect one more 0.25% interest rate hike this year, while 7 FOMC members expect no change before the end of the year.</span>
<span class="attribution"><a class="source" href="https://www.statista.com/chart/29055/fomc-projections-for-the-federal-funds-rate/">Statista</a>, <a class="license" href="http://creativecommons.org/licenses/by-nd/4.0/">CC BY-ND</a></span>
</figcaption>
</figure>
<h2>What has this got to do with bond yields?</h2>
<p>The expected rise in US rates means investors do not want to hold US bonds whose value will fall as a result. As explained before, when newer bonds are issued at higher yields (to reflect the bank’s most recent interest rate decison), existing bonds (those previously issued with lower yields) will be valued less by investors because they will get less in interest payments for holding them.</p>
<p>This is why investors are selling US bonds. For a related, but slightly different reason, investors also don’t want to hold UK bonds. As US bonds will soon earn a higher yield, investors are selling UK bonds to reposition their portfolios towards the US, where they will be able to earn a higher yield.</p>
<p>This also has implications for the value of the pound. Since the Bank of England’s decision not to raise the interest rate in September, the value of the pound has <a href="https://www.cnbc.com/2023/10/03/sterling-had-its-worst-month-for-a-year-and-it-may-fall-further.html">fallen</a> versus the US dollar. This is because the same investors that are selling UK Treasuries and driving up yields, are also selling pounds to buy US dollars. </p>
<p>The UK is not alone in feeling this effect, the euro is also weakening and against the US dollar, while the Japanese yen is close to the same low that prompted <a href="https://www.reuters.com/markets/asia/japan-likely-spent-record-amount-october-prop-up-yen-2022-10-31/">an intervention by the Bank of Japan</a> around this time last year. </p>
<figure class="align-center ">
<img alt="Globe surrounded by currency symbols on different types of bank notes." src="https://images.theconversation.com/files/552529/original/file-20231006-15-r7s87l.jpg?ixlib=rb-1.1.0&q=45&auto=format&w=754&fit=clip" srcset="https://images.theconversation.com/files/552529/original/file-20231006-15-r7s87l.jpg?ixlib=rb-1.1.0&q=45&auto=format&w=600&h=400&fit=crop&dpr=1 600w, https://images.theconversation.com/files/552529/original/file-20231006-15-r7s87l.jpg?ixlib=rb-1.1.0&q=30&auto=format&w=600&h=400&fit=crop&dpr=2 1200w, https://images.theconversation.com/files/552529/original/file-20231006-15-r7s87l.jpg?ixlib=rb-1.1.0&q=15&auto=format&w=600&h=400&fit=crop&dpr=3 1800w, https://images.theconversation.com/files/552529/original/file-20231006-15-r7s87l.jpg?ixlib=rb-1.1.0&q=45&auto=format&w=754&h=503&fit=crop&dpr=1 754w, https://images.theconversation.com/files/552529/original/file-20231006-15-r7s87l.jpg?ixlib=rb-1.1.0&q=30&auto=format&w=754&h=503&fit=crop&dpr=2 1508w, https://images.theconversation.com/files/552529/original/file-20231006-15-r7s87l.jpg?ixlib=rb-1.1.0&q=15&auto=format&w=754&h=503&fit=crop&dpr=3 2262w" sizes="(min-width: 1466px) 754px, (max-width: 599px) 100vw, (min-width: 600px) 600px, 237px">
<figcaption>
<span class="caption">Global currency markets.</span>
<span class="attribution"><a class="source" href="https://www.shutterstock.com/image-photo/world-on-international-banknotes-currency-sign-2108080049">Dilok Klaisataporn/Shutterstock</a></span>
</figcaption>
</figure>
<p>In each case, the reason is the same: the strength of the US economy relative to other economies (0.5% GDP growth for the Eurozone and 1.6% for Japan) is attracting more investors. As with the UK, the policy rates for the Eurozone and Japan are below those of the US, with each central bank indicating an intention not to make further increases.</p>
<p>But both of these effects – higher treasury yields and a depreciating pound – spell bad news for the UK economy. </p>
<p>The higher yields imply higher borrowing costs, including interest payments for the government, as well as both mortgages and business loans. The fall in the value of the pound means that imports are more expensive. Together with the fact that many commodities (such as oil) are priced in US dollars, this can contribute to higher inflation. </p>
<p>Since the economy is also barely growing, both issues will continue to have a dampening effect on the UK.</p><img src="https://counter.theconversation.com/content/215188/count.gif" alt="The Conversation" width="1" height="1" />
<p class="fine-print"><em><span>David McMillan does not work for, consult, own shares in or receive funding from any company or organisation that would benefit from this article, and has disclosed no relevant affiliations beyond their academic appointment.</span></em></p>Rates are now higher than after Liz Truss’s 2022 mini-budget.David McMillan, Professor in Finance, University of StirlingLicensed as Creative Commons – attribution, no derivatives.tag:theconversation.com,2011:article/2139162023-09-27T12:26:31Z2023-09-27T12:26:31ZWhy central banks should stop raising interest rates<p>Mortgage borrowers breathed a sign of relief following <a href="https://www.bbc.co.uk/news/business-57764601">a recent pause</a> in the Bank of England’s 14-month campaign of base rate hikes.</p>
<p>Led by the US Federal Reserve, many of the world’s <a href="https://www.bis.org/statistics/cbpol.htm">major central banks</a>, including the <a href="https://www.ecb.europa.eu/press/pr/date/2023/html/ecb.mp230914%7Eaab39f8c21.en.html">European Central Bank</a> (ECB) and the <a href="https://www.bankofengland.co.uk/monetary-policy/the-interest-rate-bank-rate">Bank of England</a>, have been hiking their main rates of interest for more than a year in a bid to slow <a href="https://data.oecd.org/price/inflation-cpi.htm">rapid price inflation</a>.</p>
<p><strong>Rising rates</strong></p>
<figure class="align-center zoomable">
<a href="https://images.theconversation.com/files/549577/original/file-20230921-17-mqzlhx.png?ixlib=rb-1.1.0&q=45&auto=format&w=1000&fit=clip"><img alt="Line chart showing rates rising in steps for UK, US and Eurozone but staying level for Japan." src="https://images.theconversation.com/files/549577/original/file-20230921-17-mqzlhx.png?ixlib=rb-1.1.0&q=45&auto=format&w=754&fit=clip" srcset="https://images.theconversation.com/files/549577/original/file-20230921-17-mqzlhx.png?ixlib=rb-1.1.0&q=45&auto=format&w=600&h=332&fit=crop&dpr=1 600w, https://images.theconversation.com/files/549577/original/file-20230921-17-mqzlhx.png?ixlib=rb-1.1.0&q=30&auto=format&w=600&h=332&fit=crop&dpr=2 1200w, https://images.theconversation.com/files/549577/original/file-20230921-17-mqzlhx.png?ixlib=rb-1.1.0&q=15&auto=format&w=600&h=332&fit=crop&dpr=3 1800w, https://images.theconversation.com/files/549577/original/file-20230921-17-mqzlhx.png?ixlib=rb-1.1.0&q=45&auto=format&w=754&h=417&fit=crop&dpr=1 754w, https://images.theconversation.com/files/549577/original/file-20230921-17-mqzlhx.png?ixlib=rb-1.1.0&q=30&auto=format&w=754&h=417&fit=crop&dpr=2 1508w, https://images.theconversation.com/files/549577/original/file-20230921-17-mqzlhx.png?ixlib=rb-1.1.0&q=15&auto=format&w=754&h=417&fit=crop&dpr=3 2262w" sizes="(min-width: 1466px) 754px, (max-width: 599px) 100vw, (min-width: 600px) 600px, 237px"></a>
<figcaption>
<span class="caption">Central bank interest rates.</span>
<span class="attribution"><a class="source" href="https://www.bis.org/statistics/cbpol.htm">Bank for International Settlements (BIS)</a></span>
</figcaption>
</figure>
<p>While the ECB increased rates at its September 2023 meeting, the Bank of England has again followed <a href="https://www.reuters.com/markets/rates-bonds/fed-projections-show-if-soft-landing-is-new-baseline-or-baseless-2023-09-20/">the Fed’s latest decision</a> to pause. </p>
<p>There are <a href="https://www.bankofengland.co.uk/monetary-policy/upcoming-mpc-dates">two more opportunities</a> for a UK rise before the end of the year and <a href="https://www.bankofengland.co.uk/monetary-policy-summary-and-minutes/2023/september-2023#:%7E:text=September%20MPC%20decision.-,Market%20pricing,-in%20the%20immediate">financial markets are expecting</a> rates to go from 5.25% to 5.5%. But the outlook for inflation, recession and the labour market – not to mention how the Fed’s rate changes can affect other economies – indicates that, if rates aren’t cut, the current pause should at least last longer than a couple of months.</p>
<p>The <a href="https://www.ecb.europa.eu/press/pr/date/2023/html/ecb.mp230914%7Eaab39f8c21.en.html">ECB’s latest decision</a> to increase its key interest rate by 0.25% was made despite its expectation that Eurozone inflation will continue to fall. The region faces a unique challenge, however. </p>
<p>Although overall inflation is 5.2%, there is a huge gap between its members – from Spain (2.4%) to Slovakia (9.6%). Differences in inflation and growth indicate <a href="https://link.springer.com/book/10.1007/978-3-030-88185-6">incomplete integration</a> of the region, which does not make the ECB’s job of balancing the economy simple.</p>
<p>In other parts of the world, particularly East Asia, inflation has come down very sharply and is expected to remain low. While UK inflation is higher than in the US, Eurozone and Japan, it is also <a href="https://www.ons.gov.uk/economy/inflationandpriceindices/timeseries/d7g7/mm23">on a downward trajectory</a>. </p>
<hr>
<p>
<em>
<strong>
Read more:
<a href="https://theconversation.com/how-the-bank-of-englands-interest-rate-hikes-are-filtering-through-to-your-finances-210344">How the Bank of England's interest rate hikes are filtering through to your finances</a>
</strong>
</em>
</p>
<hr>
<p>Mortgage rates are already high <a href="https://theconversation.com/why-mortgage-rates-will-not-return-to-recent-lows-any-time-soon-201619">and could stay that way</a>, bankruptcies are <a href="https://theconversation.com/bankruptcy-is-spiking-among-uk-borrowers-but-there-are-debt-relief-options-if-you-are-struggling-financially-213413">spiking</a> and there is a <a href="https://www.ons.gov.uk/economy/grossdomesticproductgdp/bulletins/gdpmonthlyestimateuk/july2023">very weak</a> economic outlook. The Bank of England will need to tread carefully to ensure that attempts to lower inflation further do not <a href="https://www.theguardian.com/business/2023/sep/22/uk-recession-risk-mounts-as-higher-rates-weigh-on-firms#:%7E:text=Britain's%20economy%20is%20at%20growing,pandemic%2C%20since%20the%20financial%20crisis.">stall the economy</a>.</p>
<p>The Fed has the most space to relax monetary policy because the US has experienced a sharper decline in inflation. It is now almost level with Japan, which didn’t even rise interest rates. </p>
<p><strong>Inflation rates are slowing</strong></p>
<figure class="align-center zoomable">
<a href="https://images.theconversation.com/files/549178/original/file-20230919-25-p5v4ew.png?ixlib=rb-1.1.0&q=45&auto=format&w=1000&fit=clip"><img alt="Line chart showing inflation rates rising and then falling for US, UK, Eurozone and Japan." src="https://images.theconversation.com/files/549178/original/file-20230919-25-p5v4ew.png?ixlib=rb-1.1.0&q=45&auto=format&w=754&fit=clip" srcset="https://images.theconversation.com/files/549178/original/file-20230919-25-p5v4ew.png?ixlib=rb-1.1.0&q=45&auto=format&w=600&h=285&fit=crop&dpr=1 600w, https://images.theconversation.com/files/549178/original/file-20230919-25-p5v4ew.png?ixlib=rb-1.1.0&q=30&auto=format&w=600&h=285&fit=crop&dpr=2 1200w, https://images.theconversation.com/files/549178/original/file-20230919-25-p5v4ew.png?ixlib=rb-1.1.0&q=15&auto=format&w=600&h=285&fit=crop&dpr=3 1800w, https://images.theconversation.com/files/549178/original/file-20230919-25-p5v4ew.png?ixlib=rb-1.1.0&q=45&auto=format&w=754&h=359&fit=crop&dpr=1 754w, https://images.theconversation.com/files/549178/original/file-20230919-25-p5v4ew.png?ixlib=rb-1.1.0&q=30&auto=format&w=754&h=359&fit=crop&dpr=2 1508w, https://images.theconversation.com/files/549178/original/file-20230919-25-p5v4ew.png?ixlib=rb-1.1.0&q=15&auto=format&w=754&h=359&fit=crop&dpr=3 2262w" sizes="(min-width: 1466px) 754px, (max-width: 599px) 100vw, (min-width: 600px) 600px, 237px"></a>
<figcaption>
<span class="caption">Inflation rates, January 2021 - August 2023.</span>
<span class="attribution"><a class="source" href="https://data.oecd.org/price/inflation-cpi.htm">OECD</a></span>
</figcaption>
</figure>
<p>After the Fed’s last decision in July, its chairman Jerome Powell indicated that US interest rates, which are currently at a 22-year high, would <a href="https://www.youtube.com/watch?v=oAq-XXpfn1c&cbrd=1">remain high for some time, explaining</a> that “we need to see that inflation is durably down” and that “core inflation is still pretty elevated”.</p>
<p>While “durably down” is a vague measure, <a href="https://www.investopedia.com/terms/c/coreinflation.asp">core inflation</a> (the change in the price of a basket of goods and services, excluding items prone to price spikes such as energy) <a href="https://www.whitehouse.gov/wp-content/uploads/2023/07/June-CPI-Blog_Figure1.png?resize=1822,1280">has come down significantly</a> in the US. It was well below headline inflation (the overall rate for everything measured by the consumer price index) for most of the last two years.</p>
<p>Core inflation usually moves slower than the more volatile headline rate. But an important point that’s been absent from recent rate discussions is the influence of headline inflation on core inflation. Core and headline inflation <a href="https://www.frbsf.org/economic-research/publications/economic-letter/2011/august/headline-inflation-core-convergence/">tend to converge</a> over time, which implies that when the headline rate decreases it will eventually drag on core inflation, causing overall inflation to slow. </p>
<p>As last year’s <a href="https://fred.stlouisfed.org/series/PNRGINDEXM">high energy prices</a> drop out of yearly inflation calculations, headline and core rates should dip further in most countries, including the UK. And the good news for the UK is that its core inflation <a href="https://www.ons.gov.uk/economy/inflationandpriceindices/bulletins/consumerpriceinflation/august2023">is already coming down</a> – even faster, in fact, than the headline rate.</p>
<h2>Wage watch and recession outlook</h2>
<p>Another reason for central bank caution about further monetary tightening is the weakening labour market outlook. In the US, wage growth has <a href="https://www.atlantafed.org/chcs/wage-growth-tracker">slowed</a> significantly and job vacancies have <a href="https://fred.stlouisfed.org/series/JTSJOL">declined</a>. The latter means that companies will have less need to use high wages to attract candidates. Meanwhile, lower wage growth leaves people with less money to spend, helping to slow price inflation.</p>
<p>In the UK, real wages have <a href="https://www.ons.gov.uk/employmentandlabourmarket/peopleinwork/employmentandemployeetypes/bulletins/averageweeklyearningsingreatbritain/september2023">barely left negative territory</a>. Since the beginning of last year, wages were contracting in real terms as inflation remained a lot higher than pay increases.</p>
<p>In both cases, this also implies that the much-feared <a href="https://www.bis.org/publ/bisbull53.pdf">wage-price</a> spiral hasn’t happened.</p>
<p>Of course, using rate rises to slow inflation is a difficult balancing act: hike too much and central banks choke the economy altogether. This is what the US Fed shall be worried about following the appearance of “yield curve <a href="https://www.bloomberg.com/news/articles/2023-09-14/the-bond-market-has-never-sounded-recession-alarms-for-this-long?leadSource=uverify%20wall">inversion</a>” in US bonds. </p>
<p>This is when there is a surge in demand for long-term government bonds versus short-term. An inversion is thought to <a href="https://www.reuters.com/breakingviews/new-economic-rules-shatter-us-bonds-crystal-ball-2023-09-19/#:%7E:text=But%20after%20substantial%20government%20intervention,ball%20is%20all%20but%20shattered.&text=The%20yield%20on%20two%2Dyear%20U.S.%20Treasury%20notes%20has%20been,yield%20curve%20inversion%20since%201980.">indicate</a> an upcoming recession because it shows investors are worried about the economy.</p>
<hr>
<p>
<em>
<strong>
Read more:
<a href="https://theconversation.com/fed-hopes-for-soft-landing-for-the-us-economy-but-history-suggests-it-wont-be-able-to-prevent-a-recession-182270">Fed hopes for ‘soft landing’ for the US economy, but history suggests it won’t be able to prevent a recession</a>
</strong>
</em>
</p>
<hr>
<p>This is probably why the Fed hasn’t pressed ahead with further tightening at this time. The UK is now seeing similar signs, with economic growth expressed as <a href="https://www.ons.gov.uk/economy/grossdomesticproductgdp/bulletins/gdpmonthlyestimateuk/july2023">monthly real GDP</a> estimated to have fallen by 0.5% in July 2023.</p>
<figure class="align-center ">
<img alt="Sign for Bank station and Threadneedle Street in front of the Bank of England building." src="https://images.theconversation.com/files/550576/original/file-20230927-25-svvfgn.jpg?ixlib=rb-1.1.0&q=45&auto=format&w=754&fit=clip" srcset="https://images.theconversation.com/files/550576/original/file-20230927-25-svvfgn.jpg?ixlib=rb-1.1.0&q=45&auto=format&w=600&h=400&fit=crop&dpr=1 600w, https://images.theconversation.com/files/550576/original/file-20230927-25-svvfgn.jpg?ixlib=rb-1.1.0&q=30&auto=format&w=600&h=400&fit=crop&dpr=2 1200w, https://images.theconversation.com/files/550576/original/file-20230927-25-svvfgn.jpg?ixlib=rb-1.1.0&q=15&auto=format&w=600&h=400&fit=crop&dpr=3 1800w, https://images.theconversation.com/files/550576/original/file-20230927-25-svvfgn.jpg?ixlib=rb-1.1.0&q=45&auto=format&w=754&h=503&fit=crop&dpr=1 754w, https://images.theconversation.com/files/550576/original/file-20230927-25-svvfgn.jpg?ixlib=rb-1.1.0&q=30&auto=format&w=754&h=503&fit=crop&dpr=2 1508w, https://images.theconversation.com/files/550576/original/file-20230927-25-svvfgn.jpg?ixlib=rb-1.1.0&q=15&auto=format&w=754&h=503&fit=crop&dpr=3 2262w" sizes="(min-width: 1466px) 754px, (max-width: 599px) 100vw, (min-width: 600px) 600px, 237px">
<figcaption>
<span class="caption">The Bank of England is on Threadneedle Street in London.</span>
<span class="attribution"><a class="source" href="https://www.shutterstock.com/image-photo/london-may-2023-bank-england-city-2312894195">William Barton/Shutterstock</a></span>
</figcaption>
</figure>
<h2>Following the Fed’s lead</h2>
<p>Fed decisions have global consequences. Research shows its monetary policy decisions have <a href="https://www.federalreserve.gov/econres/notes/feds-notes/international-spillovers-of-tighter-monetary-policy-20221222.html">spillover effects</a> on the rest of the world in terms of the impact of a rate rise on exchange rates and the long-term cost of borrowing. </p>
<p>If the Bank of England, the ECB and other central banks overreact to these spillover effects on their own economies, they may over-tighten monetary policy (that is, raise rates too high) and trigger a recession. </p>
<p>Central banks seem to have been in a race to the top when it comes to rate rises. The US has been setting the pace so it might be time for Fed-led tightening cycle to stop because elevated interest rates are not helping the global economy.</p><img src="https://counter.theconversation.com/content/213916/count.gif" alt="The Conversation" width="1" height="1" />
<p class="fine-print"><em><span>Muhammad Ali Nasir does not work for, consult, own shares in or receive funding from any company or organisation that would benefit from this article, and has disclosed no relevant affiliations beyond their academic appointment.</span></em></p>Central banks balance different factors when raising rates – or not – including inflation and the labour market. But what other countries are doing also has an effect.Muhammad Ali Nasir, Associate Professor in Economics, University of LeedsLicensed as Creative Commons – attribution, no derivatives.tag:theconversation.com,2011:article/2141672023-09-25T15:47:12Z2023-09-25T15:47:12ZInflation: I’ve been analysing the Bank of England’s forecasts over the past two years – here’s how they got it wrong<p>The Bank of England (BoE) has been <a href="https://www.independent.co.uk/business/bank-of-england-admits-it-made-errors-in-uk-inflation-forecasts-b2344105.html">strongly criticised</a> for failing to predict the surge in inflation. Had it done so, it could have reacted more quickly and prevented inflation from rising <a href="https://www.ons.gov.uk/economy/inflationandpriceindices/timeseries/d7g7/mm23">as high as 11%</a> in autumn 2022. </p>
<p>The bank acknowledges this failing and <a href="https://www.bankofengland.co.uk/news/2023/july/ben-bernanke-to-lead-review-into-forecasting-at-bank-of-england">has asked</a> former Federal Reserve chairman Ben Bernanke to lead a review of its forecasting models for both inflation and GDP growth.</p>
<p>I’ve been doing my own analysis of the BoE’s record by comparing how it has performed relative to other forecasting models. This demonstrates the scale of the bank’s failing – and it turns out to have been compounded by a second error that may have made the situation worse. </p>
<h2>Different forecasting models</h2>
<p>The bank is not completely transparent about how it forecasts inflation, drawing on a number of in-house <a href="https://www.bankofengland.co.uk/working-paper/2013/the-boes-forecasting-platform-compass-maps-ease-and-the-suite-of-models#:%7E:text=The%20platform%20consists%20of%20four,and%20EASE%2C%20a%20user%20interface.">mathematical models</a>. It also factors in market expectations of interest rates and the bank’s judgement of where variables such as energy prices and the pound are heading. In my analysis, I refer to this as <a href="https://www.bankofengland.co.uk/monetary-policy-report/2023/august-2023">model 1</a>.</p>
<p>As for the alternatives, model 2 is called a <a href="https://en.m.wikipedia.org/wiki/Quantile_regression">“quantile” model</a>. It incorporates three elements: a measure of whether the economy is overheating, known as the <a href="https://www.imf.org/external/pubs/ft/fandd/2013/09/basics.htm#:%7E:text=The%20output%20gap%20is%20an,that%20is%2C%20at%20full%20capacity.">output gap</a>; the history of inflation; and the effect of quantitative easing (QE), in which central banks have tried to stimulate their economies by “creating” money. </p>
<p>Model 3, known as an <a href="https://en.wikipedia.org/wiki/Vector_autoregression#:%7E:text=A%20VAR%20model%20describes%20the,k%20%C3%97%201)%2Dmatrix">econometric vector autoregressive (VAR)</a> model, seeks to fully capture international effects on the UK economy. It looks at the interactions between pressures in the <a href="https://www.newyorkfed.org/research/policy/gscpi#/overview">global supply chain</a>, the output gap, inflation and the Bank of England benchmark <a href="https://www.bankofengland.co.uk/boeapps/database/Bank-Rate.asp">interest rate</a>. It also incorporates <a href="https://fred.stlouisfed.org/series/WTISPLC">oil prices</a> and <a href="https://www.matteoiacoviello.com/gpr_country.htm">global geopolitical risk</a>, which tends to be be ignored by forecasting models. </p>
<p>Meanwhile, model 4 is a lot simpler, looking purely at the history of inflation to predict where it’s heading (we call this an <a href="https://en.wikipedia.org/wiki/Autoregressive_model">autoregressive (AR) model</a>). </p>
<p>I’ve calculated what each model would have predicted for inflation between 2008 and 2023. I’ve also calculated a median showing the combined predictions of the models, since <a href="https://doi.org/10.1016/j.jimonfin.2014.02.006">this often improves</a> results. For the sake of simplicity, I’ve focused on short-term forecasts, meaning those that predict for the coming three months (in other words, one quarter ahead). Looking at the bank’s short-term forecasting is important since this relates closely to its medium-term forecasts. </p>
<h2>How they compare</h2>
<p>The table below ranks these predictions based on a statistical test called the <a href="https://eviews.com/help/helpintro.html#page/content/series-Forecast_Evaluation.html">root mean squared error</a>: the closer to a score of zero, the more accurate the model. </p>
<p><strong>Inflation model accuracy</strong></p>
<p>Over the entire 15-year period, the BoE forecasts actually top the table. The median is only marginally behind in second place, followed by model 2. </p>
<p>Yet when you focus on the past two years, the period that really matters because inflation has been so high, a different picture emerges. Now, first place goes to model 3, whereas the BoE predictions fall to third place. </p>
<p>You get further insights by viewing the predictions in graph form against the path of inflation:</p>
<p><strong>UK inflation predictions 2021-23</strong></p>
<p>This demonstrates the bank’s under-predicting of inflation in 2021 (red line vs black line) – particularly compared to the international VAR model, in yellow. </p>
<p>It also shows the bank substantially <em>over-predicted</em> peak inflation in the final quarter of 2022, expecting 13.1% when it came in at 10.8%. After making that prediction in August 2022, the bank raised the benchmark interest rate by 0.5 points when it had previously only been raising at 0.25 points. It then raised by 0.5 points in September and by 0.75 points in November. </p>
<p>Without this over-prediction, the bank may not have sanctioned such panic rises. This would have put less pressure on the public and potentially made it <a href="https://www.livemint.com/news/india/uk-to-slip-into-recession-before-2024-end-heres-what-we-know-11691594594360.html">less likely</a> that the UK will tip into recession in the coming months. </p>
<p>The next graph plots the models’ inflation predictions since 2008. It shows the BoE considerably under-predicted inflation after initiating QE in 2009, raising questions about its understanding of the impact of the policy. Note that model 2, which attempts to take QE into account, did a much better job in that period, whereas it was one of several occasions when model 3 was less accurate. </p>
<p><strong>UK inflation predictions 2008-23</strong></p>
<h2>Thoughts for the future</h2>
<p>The <a href="https://www.ons.gov.uk/economy/inflationandpriceindices">latest inflation data</a>, published on September 20, point to 6.8% inflation in the third quarter of 2023. I’ve included this in the first graph above, and you can see that the BoE’s forecasts from a few months ago predict this fairly well, as does model 3 (the other models are over-predicting). </p>
<p>Be that as it may, the key point is that to predict inflation accurately, it is important to forecast from different models and to combine forecasts. Relying on a single forecast can often mislead and does no favours to the economics profession. The bank does publish a <a href="https://www.bankofengland.co.uk/quarterly-bulletin/1998/q1/the-inflation-report-projections-understanding-the-fan-chart">fan chart</a> that shows the probability that inflation will be above or below particular values, but this doesn’t always make things better: when it predicted 13.1% inflation for the final quarter of 2022, it attached a 50% probability to inflation being even higher. </p>
<p><strong>Bank of England inflation fan chart</strong></p>
<figure class="align-center zoomable">
<a href="https://images.theconversation.com/files/550045/original/file-20230925-17-w9z8mp.png?ixlib=rb-1.1.0&q=45&auto=format&w=1000&fit=clip"><img alt="Bank of England inflation forecast" src="https://images.theconversation.com/files/550045/original/file-20230925-17-w9z8mp.png?ixlib=rb-1.1.0&q=45&auto=format&w=754&fit=clip" srcset="https://images.theconversation.com/files/550045/original/file-20230925-17-w9z8mp.png?ixlib=rb-1.1.0&q=45&auto=format&w=600&h=259&fit=crop&dpr=1 600w, https://images.theconversation.com/files/550045/original/file-20230925-17-w9z8mp.png?ixlib=rb-1.1.0&q=30&auto=format&w=600&h=259&fit=crop&dpr=2 1200w, https://images.theconversation.com/files/550045/original/file-20230925-17-w9z8mp.png?ixlib=rb-1.1.0&q=15&auto=format&w=600&h=259&fit=crop&dpr=3 1800w, https://images.theconversation.com/files/550045/original/file-20230925-17-w9z8mp.png?ixlib=rb-1.1.0&q=45&auto=format&w=754&h=325&fit=crop&dpr=1 754w, https://images.theconversation.com/files/550045/original/file-20230925-17-w9z8mp.png?ixlib=rb-1.1.0&q=30&auto=format&w=754&h=325&fit=crop&dpr=2 1508w, https://images.theconversation.com/files/550045/original/file-20230925-17-w9z8mp.png?ixlib=rb-1.1.0&q=15&auto=format&w=754&h=325&fit=crop&dpr=3 2262w" sizes="(min-width: 1466px) 754px, (max-width: 599px) 100vw, (min-width: 600px) 600px, 237px"></a>
<figcaption>
<span class="caption"></span>
<span class="attribution"><a class="source" href="https://www.bankofengland.co.uk/monetary-policy-report/2023/august-2023">Bank of England</a></span>
</figcaption>
</figure>
<p>So where do we go from here? The BoE could pioneer being open about its inflation model and holding a “<a href="https://www.ft.com/content/7601c239-72e7-4b55-8030-5f240555a4a9">prediction tournament</a>” in which the model’s effectiveness would be measured against rivals. </p>
<p>This open-sourcing of forecasting is not a new idea. In the 1980s and 1990s <a href="https://warwick.ac.uk/fac/soc/economics/staff/academic/wallis/">Professor Kenneth Wallis</a> of the University of Warwick used to run an <a href="https://warwick.ac.uk/fac/soc/economics/research/centres/esrc/more/">annual conference</a> for the Economic and Social Research Council, the leading funder of academic economic research. Its aim was to assess the economic forecasting models of various institutions including HM Treasury, BoE, London Business School and the National Institute of Economic and Social Research. </p>
<p>Afterwards, his research team published a report comparing each model. Sadly, this brainstorming activity was discontinued in 1999. As part of his review into the BoE’s forecasting, Ben Bernanke could start by suggesting this annual conference be revived, possibly to be held at the bank itself.</p><img src="https://counter.theconversation.com/content/214167/count.gif" alt="The Conversation" width="1" height="1" />
<p class="fine-print"><em><span>Costas Milas has received in the past funding by the Bank of England to work, as the principal investigator, on the project Liquidity and Output Growth in the UK. Costas Milas has received in the past ESRC funding as the principal organiser of an ESRC Seminar Series on Nonlinearities in Economics and Finance.</span></em></p>The bank’s review into its failure to predict the inflation surge misses a second equally important blunder a few months later.Costas Milas, Professor of Finance, University of LiverpoolLicensed as Creative Commons – attribution, no derivatives.tag:theconversation.com,2011:article/2125512023-08-30T15:13:33Z2023-08-30T15:13:33ZCentral banks say interest rates will stay high but it’s unclear if this will be enough to curb inflation<figure><img src="https://images.theconversation.com/files/545512/original/file-20230830-21-i0qm7l.jpg?ixlib=rb-1.1.0&rect=0%2C223%2C4019%2C2414&q=45&auto=format&w=496&fit=clip" /><figcaption><span class="caption">Central bankers, policymakers and academics meet annually at Jackson Hole, Wyoming to discuss the economy.</span> <span class="attribution"><a class="source" href="https://www.shutterstock.com/image-photo/jackson-hole-wyoming-landscape-photos-2276541363">Sarah Hollemans/Shutterstock</a></span></figcaption></figure><p>The US central bank, the Federal Reserve, has recently signalled that it will keep interest rates high for as long as it takes to bring inflation down to its 2% target. </p>
<p>Other major central banks, such as the UK’s Bank of England and the European Central Bank (ECB), are likely to follow suit. But rate-setters face some dilemmas when it comes to balancing the use of interest rates to slow the economy versus the risk of a recession.</p>
<p>In an August 25 speech during <a href="https://www.federalreserve.gov/newsevents/speech/powell20220826a.htm">the annual Jackson Hole Symposium</a>, an <a href="https://www.nytimes.com/2023/08/24/business/economy/jackson-hole-economic-conference.html#:%7E:text=High%20on%20its%20list%20of,Fed%20event%20of%20the%20year.">influential summer gathering</a> of central bankers, policymakers and academics, chairman Jerome Powell indicated that the Fed is not yet convinced it has won the battle against inflation. This is despite the <a href="https://www.usinflationcalculator.com/inflation/current-inflation-rates/">US headline rate of inflation</a> falling from 8.5% in March 2022 (when the Fed started raising rates) to 3.2% in July.</p>
<p>Powell did suggest the central bank might start to slow the pace of rate rises after <a href="https://www.reuters.com/markets/rates-bonds/fed-poised-hike-rates-markets-anticipate-inflation-endgame-2023-07-26/#:%7E:text=The%20hike%2C%20the%20Fed's%2011th,exceeded%20for%20about%2022%20years.">11 consecutive rises</a> in interest rates to 5.5% in little more than a year. As in other regions, such as the UK and EU, recent rapid increases have reversed around <a href="https://www.macrotrends.net/2015/fed-funds-rate-historical-chart">a decade of ultra-low rates</a>. </p>
<p>This leads to even higher interest rates being charged by financial institutions, and so is designed to slow the economy. But if taken too far, it could also trigger a recession.</p>
<p>The Jackson Hole meeting is closely watched by financial markets, governments and the media for indications of the long-term direction of monetary policy, and for deeper insights into the challenges facing the world’s central banks. And so the speech was <a href="https://edition.cnn.com/business/live-news/markets-jackson-hole-fed-meeting/index.html#:%7E:text=Stocks%20fall%20as%20traders%20digest,and%20the%20Nasdaq%20dropped%200.3%25.">a disappointment to financial markets</a>, which have been rocked by recent sharp interest rates hikes. </p>
<p>For more than a decade, stock markets boomed on the back of near-zero interest rates, with the US Dow Jones Industrial Average (DJIA) <a href="https://www.macrotrends.net/1319/dow-jones-100-year-historical-chart">quadrupling</a>. But as the Fed started raising rates, the DJIA plummeted by 20%, with a short-lived recovery that soon fizzled out. And so, market hopes for a rate cut this year have been dashed – although Powell did suggest that how far and how fast rates would rise remains up for debate. </p>
<p>Indeed, Powell warned of the potential for more pain to come for households and businesses either way. Reducing inflation inevitably leads to below-trend economic growth, which causes companies to reduce pay and hiring activity. Outlining central banks’ current balancing act, <a href="https://www.federalreserve.gov/newsevents/speech/powell20220826a.htm">he said</a>: “These are the unfortunate costs of reducing inflation. But a failure to restore price stability would mean far greater pain.”</p>
<p>Similar sentiments were <a href="https://www.ecb.europa.eu/press/key/date/2023/html/ecb.sp230825%7E77711105fe.en.html">echoed by ECB president Christine Lagarde</a> at Jackson Hole. The Eurozone is also in the middle of sharply raising interest rates, despite slumping economic growth. While Largarde emphasised that the ECB must aim to keep inflation at 2% in the medium term, she also said: “There is no pre-existing playbook for the situation we are facing today – and so our task is to draw up a new one.”</p>
<p>Indeed, it remains to be seen if the world economy is entering a new phase of high inflation and weak growth, or whether the conditions that have led to the recent inflationary surge are temporary.</p>
<h2>Are we in a new economic era of high inflation?</h2>
<p>At Jackson Hole, Powell highlighted the need to ensure that public expectations of continued rapid inflation do not become entrenched. This could trigger a wage-price spiral that could get out of control. He warned that the cost of inaction would, therefore, be even higher.</p>
<p>Indeed, all of the major central banks, including the Fed, dramatically underestimated the effect of the pandemic on inflation. They have been <a href="https://www.reuters.com/world/uk/ex-officials-say-bank-england-was-too-slow-heed-inflation-warnings-2023-07-05/">criticised for not acting in time</a> and are now scrambling to rapidly increase interest rates. But why didn’t the central banks’ economic forecasting models predict rising inflation?</p>
<p>Gita Gopinath, the IMF deputy director, <a href="https://www.kansascityfed.org/Jackson%20Hole/documents/9090/Remarks_by_Gopinath.pdf">argued at Jackson Hole</a> that central bank models are outdated because they underestimated the long-term effects of supply-side disruptions. She suggested that recent failures to stop inflation rises fast enough have seriously damaged central banks’ credibility. As a result, they can no longer hope to ignore short bursts of inflation without serious consequences. She also raised the possibility that, in the long term, weaker economic growth might indeed be the price of curbing inflation.</p>
<p>Several policymakers, including Barack Obama’s former economic adviser Jason Furman, <a href="https://www.kansascityfed.org/Jackson%20Hole/documents/9674/JH2022_Furman.pdf">also in attendance at Jackson Hole</a>, have even suggested that revising central banks’ target rate of inflation to 3% from 2% would be no bad thing. This is still heresy for most central bankers, who believe making such a significant change to their remit would damage their credibility even more.</p>
<h2>Dilemmas facing central banks</h2>
<p>The Jackson Hole meeting highlighted three key dilemmas for central banks.</p>
<p>First, is the medicine (rate rises) working? While inflation has fallen, core rates in the UK, EU and US are still well above the 2% target. It’s unclear whether slowing demand in the economy is the right approach when inflation has been caused by “supply-side disruption” (pandemic-era supply shortages and the commodity-related effects of Russia’s invasion of Ukraine left too much money chasing too few goods). </p>
<p>And since higher interest rates <a href="https://www.bankofengland.co.uk/-/media/boe/files/speech/2023/february/expectations-lags-and-the-transmission-of-monetary-policy-speech-by-catherine-l-mann.pdf">can take up to 18 months to work</a>, it is hard to judge yet whether economic growth has slowed enough due to higher rates.</p>
<p>Second, it’s unclear how much more economic pain it will take to contain inflation. This question is particularly acute for the ECB and the Bank of England – economic growth in the EU and UK has been much more anaemic and inflation higher than in the US.</p>
<p>Finally, central banks face real challenges in trying to restore their credibility. Given major uncertainty about the future of the world economy, they face the unenviable task of either taking a wait-and-see approach until trends are clearer, or taking pre-emptive action to re-assert their credibility and prevent the worst if inflation remains persistent. </p>
<p>As the global economy cools, particularly driven by recent <a href="https://www.vox.com/world-politics/2023/8/29/23845841/chinas-economy-xi-expert">weak economic growth in China</a>, these trade-offs will only become harder to make.</p><img src="https://counter.theconversation.com/content/212551/count.gif" alt="The Conversation" width="1" height="1" />
<p class="fine-print"><em><span>Steve Schifferes does not work for, consult, own shares in or receive funding from any company or organisation that would benefit from this article, and has disclosed no relevant affiliations beyond their academic appointment.</span></em></p>The world’s central banks face a range of dilemmas, not least whether high inflation – and therefore high interest rates – will become permanent.Steve Schifferes, Honorary Research Fellow, City Political Economy Research Centre, City, University of LondonLicensed as Creative Commons – attribution, no derivatives.tag:theconversation.com,2011:article/2110502023-08-04T14:19:20Z2023-08-04T14:19:20ZUK interest rates: crashing the economy is no way to bring down inflation<figure><img src="https://images.theconversation.com/files/541238/original/file-20230804-495-ugyy8l.jpeg?ixlib=rb-1.1.0&q=45&auto=format&w=496&fit=clip" /><figcaption><span class="caption">It won't hurt a bit. </span> <span class="attribution"><a class="source" href="https://www.shutterstock.com/image-illustration/3d-illustration-creative-red-car-crash-2322994587">Kevin CC</a></span></figcaption></figure><p>The Bank of England (BoE) has <a href="https://www.bankofengland.co.uk/monetary-policy-summary-and-minutes/2023/august-2023">raised</a> interest rates once again to 5.25%, mirroring similar moves by the <a href="https://www.federalreserve.gov/newsevents/pressreleases/monetary20230726a.htm">Federal Reserve</a> and the <a href="https://www.ecb.europa.eu/press/pr/date/2023/html/ecb.mp230727%7Eda80cfcf24.en.html">European Central Bank</a>. The fact that the UK is still suffering from <a href="https://www.cnbc.com/2023/07/19/uk-inflation-rate-slides-to-7point9percent-in-june-below-expectations.html">high inflation</a> – higher than either <a href="https://www.bbc.co.uk/news/business-66178936">the US</a> or <a href="https://www.thetimes.co.uk/article/eurozone-surprises-with-faster-growth-as-inflation-hits-new-low-kzj7wtgj0">eurozone</a> – made another rate rise appear inevitable.</p>
<p>Yet there are reasons to doubt the merits and effectiveness of this approach. The UK’s efforts to bring down inflation quickly could be risking the health of the economy. </p>
<p>It is important to understand how monetary policy “works”. In effect, the BoE is seeking to make <a href="https://www.bbc.com/news/business-65308769">households</a> in particular poorer so they spend less. The idea is you dampen down demand to bring it into line with supply, so that upward pressure on prices can be curbed. </p>
<p>The other effect of raising rates is to reduce the wage demands of workers by <a href="https://www.theguardian.com/business/grogonomics/2023/feb/09/the-reserve-bank-wants-unemployment-to-rise-it-should-be-careful-what-it-wishes-for">creating unemployment</a>. This is not the publicly stated goal, but it lies behind the rhetoric of wage restraint that the BoE <a href="https://www.ft.com/content/4973fd9c-641f-4df2-87c3-bff77eb2406f">continually espouses</a> – despite nominal wage growth <a href="https://www.hrmagazine.co.uk/content/news/real-wages-rise-for-first-time-in-18-months/">only recently</a> matching inflation.</p>
<p>The current approach to monetary policy accepts a recession as a price worth paying, while implying a belief that higher unemployment leads to lower inflation. This can be disputed on economic grounds - in the UK in the recent past, low inflation was achieved with low unemployment, so the idea that there is a necessary trade-off between inflation and unemployment can be refuted historically. </p>
<p>There are also moral objections to current monetary policy. It can be argued that the BoE should have a responsibility to protect living standards, not harm them. Its mandate of achieving a 2% inflation target should not be at any cost. Creating unemployment will impose misery on many workers and have scarring effects on the economy, from lost skills to reduced industrial capacity, which may be difficult to heal.</p>
<h2>The economic reality</h2>
<p>The current inflation is also not a classic case of “too much money chasing too few goods”. There are pressures from higher <a href="https://www.ons.gov.uk/economy/inflationandpriceindices/articles/foodandenergypriceinflationuk/2023">food and energy prices</a> linked to factors like Brexit and the Ukraine war that cannot be controlled by raising interest rates. </p>
<p>There are also structural problems in the UK, such as labour shortages due to increases in economic inactivity – the result of more over-50s leaving the workforce and rises in ill health. These problems are seen to have put <a href="https://publications.parliament.uk/pa/ld5803/ldselect/ldeconaf/115/11504.htm">upward pressure on wages</a>, and require responses beyond raising interest rates if they are to be fully addressed. </p>
<p>For example, they require new investment in the health sector to help alleviate hospital waiting lists. A better-funded NHS would create a healthier workforce, overcoming current limits on labour supply due to poor health that are seen to be creating inflationary pressures. </p>
<p>In any case, inflation is set to come down – the BoE’s <a href="https://www.bankofengland.co.uk/-/media/boe/files/monetary-policy-report/2023/august/mpr-august-2023-opening-remarks-slides.pdf">own forecasts</a> show this. Monetary tightening at this stage is therefore short-sighted and probably counterproductive – especially when the BoE thinks deflation is distinctly possible in the next couple of years. A more cautious approach to monetary policy seems in order.</p>
<p>Other countries have followed different policies with different effects. <a href="https://www.theguardian.com/commentisfree/2023/aug/03/spain-inflation-lower-bank-england-interest-rates">Spain</a>, for instance, has used mechanisms such as price controls on things like rents and energy to help curb inflation (the UK did also cap energy bills, though not as aggressively). This has helped to reduce inflation while keeping employment high. It shows that crashing the economy is not the only route to low inflation.</p>
<p>In short, the BoE is simply compounding problems rather than solving them through its actions. It is time it learnt the limits of its own policies, while the government needs to play a role too. </p>
<p>In the short term, attention should be given to controlling prices (including energy) and making businesses show restraint in their pricing behaviour. Longer term, greater investment in skills, health and productive capacity is needed to create an economy that allows for rising real living standards with full employment.</p><img src="https://counter.theconversation.com/content/211050/count.gif" alt="The Conversation" width="1" height="1" />
<p class="fine-print"><em><span>David Spencer receives funding from the ESRC</span></em></p><p class="fine-print"><em><span>Muhammad Ali Nasir does not work for, consult, own shares in or receive funding from any company or organisation that would benefit from this article, and has disclosed no relevant affiliations beyond their academic appointment.</span></em></p>The Bank of England has just raised rates for the 14th time in a row to 5.25%.David Spencer, Professor of Economics and Political Economy, University of LeedsMuhammad Ali Nasir, Associate Professor in Economics, University of LeedsLicensed as Creative Commons – attribution, no derivatives.tag:theconversation.com,2011:article/2088532023-08-04T11:59:41Z2023-08-04T11:59:41ZFive ways to take advantage of rising interest rates to boost your savings<figure><img src="https://images.theconversation.com/files/539289/original/file-20230725-12812-rqkfwb.jpg?ixlib=rb-1.1.0&rect=186%2C28%2C6043%2C4072&q=45&auto=format&w=496&fit=clip" /><figcaption><span class="caption">It's always a good time to save more, if you can.</span> <span class="attribution"><a class="source" href="https://www.shutterstock.com/image-photo/smiling-black-woman-saving-goal-future-2253367631">tommaso79/Shutterstock</a></span></figcaption></figure><p>With the Bank of England base rate <a href="https://theconversation.com/how-the-bank-of-englands-interest-rate-hikes-are-filtering-through-to-your-finances-210344">currently the highest</a> it has been since early 2008, you may have a valuable opportunity to increase your earnings on pensions, investments and savings accounts. After all, when the central bank raises its main rate – the base rate, which is typically used as a benchmark for loans as well as savings accounts – it is trying to encourage people to spend less and save more.</p>
<p>But UK banks and building societies have <a href="https://www.independent.co.uk/money/martin-lewis-savings-rates-mortgage-crisis-b2362955.html">recently been accused</a> of letting their savings rates lag the recent rapid rise in the base rate. UK regulator the Financial Conduct Authority has urged these financial firms to offer “<a href="https://www.fca.org.uk/news/press-releases/action-plan-cash-savings">fair and competitive</a>” savings rates in response to the increasing interest rates. </p>
<hr>
<p>
<em>
<strong>
Read more:
<a href="https://theconversation.com/interest-rates-why-your-mortgage-payments-are-going-up-but-your-savings-arent-and-how-better-monetary-policy-could-help-196528">Interest rates: why your mortgage payments are going up but your savings aren't – and how better monetary policy could help</a>
</strong>
</em>
</p>
<hr>
<p>Many financial institutions do offer accounts with <a href="https://www.theguardian.com/money/2023/jul/15/uk-savings-accounts-interest-nsi-building-societies-banks-deals">rates of 6% or more</a>. This is good news for avid savers – but only if you keep an eye on the market so you can switch from less competitive products. This is why it’s important to establish a regular savings habit, but many people are unsure about what that should involve.</p>
<p>My colleagues and I have studied the <a href="https://dspace.stir.ac.uk/handle/1893/32240">correlation between people’s savings goals</a> (if they have any) and how they invest their money. We also looked at how seeking financial information advice, and being “good with numbers”, both influence this correlation. </p>
<p>We analysed data from more than 40,000 individuals in 21,000 UK households from five waves of the Office for National Statistics Wealth and Assets Survey (WAS), conducted between 2006 and 2016. This data captures comprehensive economic wellbeing information and attitudes to financial planning. </p>
<p>Our research shows the importance to your finances of setting multiple savings goals, keeping up with financial news, and seeking professional advice. Based on this, here are five research-based ways to make the most of your money.</p>
<h2>1. Set specific savings goals</h2>
<p>Establishing personal savings goals is one of the first steps most financial institutions and advisers will recommend to their customers, because it’s a good idea to <a href="https://www.investopedia.com/terms/c/compoundinterest.asp">save regularly</a>. Plus, our study shows that total financial assets increase in line with the number of savings goals you have, and that setting specific, rather than vague, goals leads to higher performance.</p>
<p>Specific savings goals should have an end date, target figure, and even a meaningful name – for example, “£1,000 for 2024 trip to Asia” or “£250 for 2023 Christmas present fund”. This will create tangible reference points that encourage self-control and increase the pain you feel if you fail to meet your goal.</p>
<figure class="align-center ">
<img alt="Three glass jars of coins with labels that say: insurance, retirement, travel plan." src="https://images.theconversation.com/files/539288/original/file-20230725-21-wi4q3k.jpg?ixlib=rb-1.1.0&q=45&auto=format&w=754&fit=clip" srcset="https://images.theconversation.com/files/539288/original/file-20230725-21-wi4q3k.jpg?ixlib=rb-1.1.0&q=45&auto=format&w=600&h=338&fit=crop&dpr=1 600w, https://images.theconversation.com/files/539288/original/file-20230725-21-wi4q3k.jpg?ixlib=rb-1.1.0&q=30&auto=format&w=600&h=338&fit=crop&dpr=2 1200w, https://images.theconversation.com/files/539288/original/file-20230725-21-wi4q3k.jpg?ixlib=rb-1.1.0&q=15&auto=format&w=600&h=338&fit=crop&dpr=3 1800w, https://images.theconversation.com/files/539288/original/file-20230725-21-wi4q3k.jpg?ixlib=rb-1.1.0&q=45&auto=format&w=754&h=425&fit=crop&dpr=1 754w, https://images.theconversation.com/files/539288/original/file-20230725-21-wi4q3k.jpg?ixlib=rb-1.1.0&q=30&auto=format&w=754&h=425&fit=crop&dpr=2 1508w, https://images.theconversation.com/files/539288/original/file-20230725-21-wi4q3k.jpg?ixlib=rb-1.1.0&q=15&auto=format&w=754&h=425&fit=crop&dpr=3 2262w" sizes="(min-width: 1466px) 754px, (max-width: 599px) 100vw, (min-width: 600px) 600px, 237px">
<figcaption>
<span class="caption">Savings goals – but try an interest-bearing account, rather than a jar.</span>
<span class="attribution"><a class="source" href="https://www.shutterstock.com/image-photo/money-coins-jars-insurance-savings-retirement-1036970458">simon jhuan/Shutterstock</a></span>
</figcaption>
</figure>
<h2>2. Seek professional financial advice</h2>
<p>Rather than relying on friends, family and social media for financial advice, speak to an expert.</p>
<p>Our research shows households that access professional financial advice were more likely to allocate a higher share of their wealth to stock portfolios than those that rely on friends, family and social media for financial advice. This result was consistent even across different wealth and income levels, with lower earners possibly using products like ISAs to make investments in stocks and shares. Other <a href="https://academic.oup.com/qje/article/134/3/1225/5435538">research shows</a> stock portfolios outperform most other types of investment in the long term.</p>
<p>We also found that access to professional financial advice can substitute for setting goals, because your adviser should help you to determine the kinds of products to invest in (which is called asset allocation) for specific timelines and aims.</p>
<h2>3. Brush up on your maths</h2>
<p><a href="https://doi.org/10.1111/j.1475-5890.2007.00052.x">Several studies</a> show numerical skills affect how households gather and process information, <a href="https://psycnet.apa.org/doi/10.1037/a0013114">set goals</a>, perceive risks, and <a href="https://heinonline.org/HOL/P?h=hein.journals/fedred89&i=791">decide to invest</a> in various financial assets. So, by brushing up on your basic numeracy and financial literacy skills – even with free online videos – you could boost your savings for the long term. </p>
<p>Our study shows that individuals with high confidence in their numerical skills tend to have better financial planning habits – such as investing more in stocks and bonds than cash, which carries more risk but also the potential for greater returns. This trend is particularly evident among households with no savings goals, suggesting that numerical ability could compensate for failing to set such goals.</p>
<figure class="align-center ">
<img alt="Overhead shot of person at desk with papers, pen & notebook, watching video on laptop of woman at a whiteboard." src="https://images.theconversation.com/files/539294/original/file-20230725-20-nsyh2z.jpg?ixlib=rb-1.1.0&q=45&auto=format&w=754&fit=clip" srcset="https://images.theconversation.com/files/539294/original/file-20230725-20-nsyh2z.jpg?ixlib=rb-1.1.0&q=45&auto=format&w=600&h=400&fit=crop&dpr=1 600w, https://images.theconversation.com/files/539294/original/file-20230725-20-nsyh2z.jpg?ixlib=rb-1.1.0&q=30&auto=format&w=600&h=400&fit=crop&dpr=2 1200w, https://images.theconversation.com/files/539294/original/file-20230725-20-nsyh2z.jpg?ixlib=rb-1.1.0&q=15&auto=format&w=600&h=400&fit=crop&dpr=3 1800w, https://images.theconversation.com/files/539294/original/file-20230725-20-nsyh2z.jpg?ixlib=rb-1.1.0&q=45&auto=format&w=754&h=503&fit=crop&dpr=1 754w, https://images.theconversation.com/files/539294/original/file-20230725-20-nsyh2z.jpg?ixlib=rb-1.1.0&q=30&auto=format&w=754&h=503&fit=crop&dpr=2 1508w, https://images.theconversation.com/files/539294/original/file-20230725-20-nsyh2z.jpg?ixlib=rb-1.1.0&q=15&auto=format&w=754&h=503&fit=crop&dpr=3 2262w" sizes="(min-width: 1466px) 754px, (max-width: 599px) 100vw, (min-width: 600px) 600px, 237px">
<figcaption>
<span class="caption">Brush up on your maths skills.</span>
<span class="attribution"><a class="source" href="https://www.shutterstock.com/image-photo/high-angle-view-video-conference-teacher-1676998303">Ground Picture/Shutterstock</a></span>
</figcaption>
</figure>
<h2>4. Adopt appropriate savings strategies</h2>
<p>Diversified stock market portfolios generally outperform bonds and cash savings <a href="https://doi.org/10.1093/qje/qjz012">over longer periods</a>. However, stock markets can be volatile, so putting savings into less risky assets like bonds and cash is wise for savings goals of less than five years.</p>
<p>In the longer term, investing across different global stock markets for more than five years can help counteract inflation. And you can access low-cost, diversified investment portfolios via financial products based on indices of stocks or other assets, such as exchange traded funds.</p>
<h2>5. Set, monitor and adjust your plan</h2>
<p>Free financial planning and budgeting apps can help you save money by tracking your spending and savings goals, and encouraging you to adhere to a budget.</p>
<p>Most importantly, once you set savings goals and create a budget, don’t forget about them. Check regularly to see how your savings are building up and to monitor for any spending changes. A growing array of fintech tools can prompt and encourage this kind of long-term planning.</p>
<p>Keeping an eye on savings rates is also important. As banks change rates or create new accounts, consider switching to get a better deal if you can do so without falling foul of account closure fees.</p>
<p>It’s important to make sure your savings are working for you at any time, but its crucial in the current economy, when finances are tight but interest rates are rising.</p><img src="https://counter.theconversation.com/content/208853/count.gif" alt="The Conversation" width="1" height="1" />
<p class="fine-print"><em><span>Fredrick Kibon Changwony does not work for, consult, own shares in or receive funding from any company or organisation that would benefit from this article, and has disclosed no relevant affiliations beyond their academic appointment.</span></em></p>Specific savings goals can help increase your pot – but so can advice and confidence with numbers.Fredrick Kibon Changwony, Lecturer in Accounting & Finance, University of StirlingLicensed as Creative Commons – attribution, no derivatives.tag:theconversation.com,2011:article/2103442023-08-03T12:56:46Z2023-08-03T12:56:46ZHow the Bank of England’s interest rate hikes are filtering through to your finances<figure><img src="https://images.theconversation.com/files/540992/original/file-20230803-15-rds3cq.jpg?ixlib=rb-1.1.0&rect=20%2C28%2C2685%2C2231&q=45&auto=format&w=496&fit=clip" /><figcaption><span class="caption">The Bank of England, London.</span> <span class="attribution"><a class="source" href="https://www.shutterstock.com/image-photo/london-uk-june-11-2015-people-451939666">Claudio Divizia/Shutterstock</a></span></figcaption></figure><p>The Bank of England has <a href="https://www.bankofengland.co.uk/monetary-policy/the-interest-rate-bank-rate">increased interest rates to 5.25%</a>, a level not seen since April 2008 and markedly higher than the all-time lows of 0.1% seen less than two years ago.</p>
<p>In fact, interest rates hovered between 0.1% and 0.75% for the 13 years to May 2022. We are now in a new era in which the Bank of England – similar to other central banks – is using rate hikes (this is the 14th consecutive increase) to try to bring price inflation down from currently just under 8% towards its <a href="https://www.bankofengland.co.uk/monetary-policy/inflation">target of 2%</a>.</p>
<p>The bank’s goal is to increase the cost of borrowing for retail banks, which then pass these costs on to households and companies. This reduces people’s spending and causes prices to rise more slowly as companies adjust to falling demand.</p>
<hr>
<p>
<em>
<strong>
Read more:
<a href="https://theconversation.com/interest-rate-hikes-are-not-the-only-tool-to-fight-uk-inflation-heres-what-the-government-should-do-208697">Interest rate hikes are not the only tool to fight UK inflation – here's what the government should do</a>
</strong>
</em>
</p>
<hr>
<p>But interest rates are often called <a href="https://theconversation.com/why-uk-inflation-is-so-high-compared-to-eu-and-us-and-what-to-do-about-it-206583">a blunt instrument</a> because adjusting them to tackle inflation has <a href="https://www.aeaweb.org/articles?id=10.1257/jep.37.1.121">an uneven effect</a>. This is because people are at different stages of their lives and have varied levels and sources of income, not to mention debt. </p>
<p>So, there are winners and losers. Here are the main factors that influence how rate changes could feed through to your finances.</p>
<h2>Do you have a mortgage?</h2>
<p>Perhaps the most obvious impact of rising interest rates is increased mortgage repayments. This tends to affect younger generations (but not the youngest) and those in the middle of the wealth distribution the most. Higher interest rates <a href="https://academic.oup.com/restud/article-abstract/87/1/102/5272505?redirectedFrom=fulltext">lead to a fall in spending</a> among these groups that is greater than the increase in their mortgage costs, which is what the bank wants to encourage.</p>
<p>However, the worst is yet to come for UK mortgage borrowers. Back in 2008, the bank started cutting interest rates to support the economy after the global financial crisis. At this time, the fee for ending a mortgage deal early to switch to a lower interest rate was often <a href="https://papers.ssrn.com/sol3/papers.cfm?abstract_id=4399613">outweighed by the savings gained</a> from the lower rate.</p>
<p>As more borrowers have been on fixed-rate mortgages as a result, people’s actual rates have risen much more slowly than the advertised rates for new mortgage deals. This chart, which includes all current UK mortgage deals, shows that rate rises have so far largely only affected variable- or floating-rate deals:</p>
<figure class="align-center ">
<img alt="Line graph showing various mortgage product repayment rates, all fairly level, slight increase, but variable rates have increased significantly." src="https://images.theconversation.com/files/540985/original/file-20230803-15-flfgk9.png?ixlib=rb-1.1.0&q=45&auto=format&w=754&fit=clip" srcset="https://images.theconversation.com/files/540985/original/file-20230803-15-flfgk9.png?ixlib=rb-1.1.0&q=45&auto=format&w=600&h=526&fit=crop&dpr=1 600w, https://images.theconversation.com/files/540985/original/file-20230803-15-flfgk9.png?ixlib=rb-1.1.0&q=30&auto=format&w=600&h=526&fit=crop&dpr=2 1200w, https://images.theconversation.com/files/540985/original/file-20230803-15-flfgk9.png?ixlib=rb-1.1.0&q=15&auto=format&w=600&h=526&fit=crop&dpr=3 1800w, https://images.theconversation.com/files/540985/original/file-20230803-15-flfgk9.png?ixlib=rb-1.1.0&q=45&auto=format&w=754&h=661&fit=crop&dpr=1 754w, https://images.theconversation.com/files/540985/original/file-20230803-15-flfgk9.png?ixlib=rb-1.1.0&q=30&auto=format&w=754&h=661&fit=crop&dpr=2 1508w, https://images.theconversation.com/files/540985/original/file-20230803-15-flfgk9.png?ixlib=rb-1.1.0&q=15&auto=format&w=754&h=661&fit=crop&dpr=3 2262w" sizes="(min-width: 1466px) 754px, (max-width: 599px) 100vw, (min-width: 600px) 600px, 237px">
<figcaption>
<span class="caption"></span>
<span class="attribution"><a class="source" href="https://www.bankofengland.co.uk/statistics/visual-summaries/effective-interest-rates">Bank of England</a></span>
</figcaption>
</figure>
<p>In contrast, this chart, which includes only new mortgage deals agreed since August 2021, shows how interest rate rises are similarly affecting repayments on all types of new deal:</p>
<figure class="align-center zoomable">
<a href="https://images.theconversation.com/files/540986/original/file-20230803-19-6dd92w.png?ixlib=rb-1.1.0&q=45&auto=format&w=1000&fit=clip"><img alt="Line chart showing sharp rise in mortgage repayment rates" src="https://images.theconversation.com/files/540986/original/file-20230803-19-6dd92w.png?ixlib=rb-1.1.0&q=45&auto=format&w=754&fit=clip" srcset="https://images.theconversation.com/files/540986/original/file-20230803-19-6dd92w.png?ixlib=rb-1.1.0&q=45&auto=format&w=600&h=526&fit=crop&dpr=1 600w, https://images.theconversation.com/files/540986/original/file-20230803-19-6dd92w.png?ixlib=rb-1.1.0&q=30&auto=format&w=600&h=526&fit=crop&dpr=2 1200w, https://images.theconversation.com/files/540986/original/file-20230803-19-6dd92w.png?ixlib=rb-1.1.0&q=15&auto=format&w=600&h=526&fit=crop&dpr=3 1800w, https://images.theconversation.com/files/540986/original/file-20230803-19-6dd92w.png?ixlib=rb-1.1.0&q=45&auto=format&w=754&h=661&fit=crop&dpr=1 754w, https://images.theconversation.com/files/540986/original/file-20230803-19-6dd92w.png?ixlib=rb-1.1.0&q=30&auto=format&w=754&h=661&fit=crop&dpr=2 1508w, https://images.theconversation.com/files/540986/original/file-20230803-19-6dd92w.png?ixlib=rb-1.1.0&q=15&auto=format&w=754&h=661&fit=crop&dpr=3 2262w" sizes="(min-width: 1466px) 754px, (max-width: 599px) 100vw, (min-width: 600px) 600px, 237px"></a>
<figcaption>
<span class="caption"></span>
<span class="attribution"><a class="source" href="https://www.bankofengland.co.uk/statistics/visual-summaries/effective-interest-rates">Bank of England</a></span>
</figcaption>
</figure>
<p>As rates rise, only those who have to refinance will choose to move to a new loan, so the effects are likely to filter through at a slower pace. But it will happen – the 4 million borrowers expected to move to new mortgage contracts over the next three years could pay <a href="https://www.theguardian.com/money/2023/jul/12/mortgage-payment-rise-bank-of-england-2026-forecast">up to £220 more a month</a> because of the current higher-rate environment.</p>
<h2>Do you own your home outright?</h2>
<p>House prices are widely expected to fall in coming months as <a href="https://www.aljazeera.com/economy/2023/8/1/uk-house-prices-drop-by-most-since-2009-amid-rising-interest-rates">rate hikes make it more difficult</a> to get a mortgage – but this will only affect people who want to buy or sell. While your house may be worth less, if you remain living in it you still get to enjoy your home regardless of its price. </p>
<p>However, a house can also be a valuable source of collateral or security for repayment of a loan, so lower house prices can mean less opportunity to borrow in difficult times. This is particularly important for <a href="https://www.jstor.org/stable/26543941">older generations</a> who may need to pay for long-term care.</p>
<h2>Do you have a pension or savings?</h2>
<p>On the other hand, older generations (and wealthier households) may benefit from higher rates because they’ve had more time to accumulate wealth. </p>
<p>Rate hikes can boost returns on savings and fixed-income assets such as bonds and <a href="https://benjaminmoll.com/wp-content/uploads/2021/11/APR_slides.pdf">annuities</a> (which provide <a href="https://www.ageuk.org.uk/information-advice/money-legal/pensions/annuities/">a fixed income stream</a> in retirement). For example, a typical 65-year-old looking to purchase an annuity with a £100,000 pension could get <a href="https://www.sharingpensions.co.uk/annuity-rates-chart-latest.htm#:%7E:text=Latest%20annuity%20rates,-How%20annuity%20rates&text=The%2015%2Dyear%20gilt%20yields%20increased%20by%20%2B10%20basis%20points,yields%20remain%20at%20current%20levels">up to £7,352 per year</a> now, compared with £4,786 at the start of 2021.</p>
<p>On the other hand, higher interest rates can make investing in the stock market less attractive. Reduced spending by the public means companies make less money for shareholders.</p>
<h2>Do you rent your home?</h2>
<p>The cost of living crisis, competition for rental properties and lack of supply of housing has led to a significant increase in costs for renters. But are they winners or losers when it comes to increases in interest rates? The picture is mixed. </p>
<p>Landlords may initially pass higher mortgage costs to renters. But, as more landlords exit the market, lower house prices could eventually cause rents to fall, as landlords need less to cover mortgage repayments. In the medium term, evidence suggests that higher interest rates ultimately <a href="https://www.frbsf.org/economic-research/publications/economic-letter/2023/february/can-monetary-policy-tame-rent-inflation/#:%7E:text=Evidence%20suggests%20that%2C%20as%20monetary,tends%20to%20adjust%20relatively%20slowly">reduce rents</a>. </p>
<p>However, renters tend to be younger, less well off, and often living paycheck to paycheck, which is more likely to leave them worse off overall.</p>
<figure class="align-center ">
<img alt="Two red and white signs saying " src="https://images.theconversation.com/files/540988/original/file-20230803-27-fpyrml.jpg?ixlib=rb-1.1.0&q=45&auto=format&w=754&fit=clip" srcset="https://images.theconversation.com/files/540988/original/file-20230803-27-fpyrml.jpg?ixlib=rb-1.1.0&q=45&auto=format&w=600&h=400&fit=crop&dpr=1 600w, https://images.theconversation.com/files/540988/original/file-20230803-27-fpyrml.jpg?ixlib=rb-1.1.0&q=30&auto=format&w=600&h=400&fit=crop&dpr=2 1200w, https://images.theconversation.com/files/540988/original/file-20230803-27-fpyrml.jpg?ixlib=rb-1.1.0&q=15&auto=format&w=600&h=400&fit=crop&dpr=3 1800w, https://images.theconversation.com/files/540988/original/file-20230803-27-fpyrml.jpg?ixlib=rb-1.1.0&q=45&auto=format&w=754&h=503&fit=crop&dpr=1 754w, https://images.theconversation.com/files/540988/original/file-20230803-27-fpyrml.jpg?ixlib=rb-1.1.0&q=30&auto=format&w=754&h=503&fit=crop&dpr=2 1508w, https://images.theconversation.com/files/540988/original/file-20230803-27-fpyrml.jpg?ixlib=rb-1.1.0&q=15&auto=format&w=754&h=503&fit=crop&dpr=3 2262w" sizes="(min-width: 1466px) 754px, (max-width: 599px) 100vw, (min-width: 600px) 600px, 237px">
<figcaption>
<span class="caption"></span>
<span class="attribution"><a class="source" href="https://www.shutterstock.com/image-photo/red-rent-sign-details-on-front-685694197">Andriy Blokhin/Shutterstock</a></span>
</figcaption>
</figure>
<h2>Do you live paycheck to paycheck?</h2>
<p>A rise in interest rates tends to mean that things become more expensive, so <a href="https://www.cato.org/research-briefs-economic-policy/expansionary-monetary-policy-increases-inequality?utm_campaign=Research%20Briefs%20in%20Economic%20Policy&utm_medium=email&_hsmi=200695551&_hsenc=p2ANqtz-_RH3P0DhUGejoN8yynX39-0Cag6DT3zwhSsvUl9f03yFSUoZmjbzlxxlNL6S_qJPx0ceYowguVC0GUmGSSE8j31q_gnw&utm_content=200695551&utm_source=hs_email">people spend less</a> and companies are unable (or don’t want to) pay workers enough to match the rise in prices. So, if even your take-home pay stays the same (or even goes a bit higher), the amount of good services you can buy with your wages falls. </p>
<p>This probably adversely affects those on lower incomes the most. The last time there was a major increase in interest rates in the 1970s, earnings losses from low-income households were <a href="https://www.jstor.org/stable/10.1086/675535">many times</a> that of high-income households. And when we consider the effects of lower incomes on spending, the gap between richer and poorer households is even greater. This is because people with no savings cushion are forced to reduce their consumption when prices rise. Around a third of UK workers are currently <a href="https://www.wtwco.com/en-gb/news/2022/06/a-third-of-uk-workers-are-living-payday-to-payday">in this category</a>.</p>
<p>On the other hand, the wealthy can draw down savings – including <a href="https://www.theguardian.com/business/2023/jun/29/uk-households-withdrawing-savings-at-fastest-ever-rate-official-figures-show">savings built up during the pandemic</a> – and continue to spend.</p>
<p>Understanding and measuring the varied impact of rate changes in the current era of increases is crucial. This should be a top priority for economists and policymakers who want to achieve stable price inflation and grow the economy, while also protecting the most vulnerable.</p><img src="https://counter.theconversation.com/content/210344/count.gif" alt="The Conversation" width="1" height="1" />
<p class="fine-print"><em><span>William Tayler does not work for, consult, own shares in or receive funding from any company or organisation that would benefit from this article, and has disclosed no relevant affiliations beyond their academic appointment.</span></em></p>Interest rate rises have an uneven effect depending on your savings, living conditions and stage of life.William Tayler, Assistant Professor in Economics, Lancaster UniversityLicensed as Creative Commons – attribution, no derivatives.tag:theconversation.com,2011:article/2086972023-06-29T15:52:57Z2023-06-29T15:52:57ZInterest rate hikes are not the only tool to fight UK inflation – here’s what the government should do<p>Over the past year, interest rates have been rising rapidly around the world. The post-COVID economic recovery and Russia’s invasion of Ukraine caused inflation to reach 10% or more in many countries. Central banks in the US, UK and Europe have fought back by raising interest rates in an attempt to cool the economy and return inflation to their 2% targets.</p>
<p>This has already hit mortgage holders whose repayments are linked to central bank rates. In the UK, the Bank of England raised its rate in June by a further 0.5 percentage points to 5%, the highest level since 2008. Households coming to the end of fixed-rate mortgage deals next year now face an average increase in annual payments of £2,900, <a href="https://www.resolutionfoundation.org/app/uploads/2023/06/The-mortgage-crunch.pdf">according to research by the Resolution Foundation</a>.</p>
<p>Worse is yet to come. Financial markets are forecasting <a href="https://www.theguardian.com/business/2023/jun/22/markets-predict-uk-interest-rate-bank-of-england">interest rates of 6%</a> by the end of the year. </p>
<p>The need for such sharp rate rises to tackle inflation can be partly traced to <a href="https://www.telegraph.co.uk/business/2023/02/23/bank-england-slow-fight-against-inflation-rate-setter-admits/">the Bank of England having been slow to act</a>. But the UK government has also made missteps over the past year by not using its fiscal policy (tax and spending) to help the Bank of England’s monetary policy (interest rate changes) defeat inflation. Central banks are expected to continue to raise rates while, in the UK, the government is simply looking on. </p>
<p>UK chancellor Jeremy Hunt has <a href="https://www.theguardian.com/business/2023/jun/23/jeremy-hunt-meets-uks-biggest-lenders-in-effort-to-quell-mortgage-crisis">met with lenders</a> and announced <a href="https://www.gov.uk/government/news/chancellor-agrees-new-support-measures-for-mortgage-holders">measures</a> to help struggling homeowners. But he has been clear that <a href="https://inews.co.uk/news/politics/jeremy-hunt-rules-out-help-mortgage-borrowers-backs-hike-interest-rates-2412428">the government will not intervene</a> by stopping rate hikes or directly subsidising homeowners’ mortgages.</p>
<h2>Can rate rises slay inflation?</h2>
<p>Hunt has said the Bank of England’s rate rises have his “<a href="https://www.reuters.com/world/uk/uks-hunt-backs-bank-england-after-latest-rate-hike-2023-06-22/">full support</a>” as “one of the most effective methods of bringing inflation down”.</p>
<p>It is true that rate rises can cool inflation by cooling the economy. By raising the repayment costs of mortgages and other sorts of loan, consumers, business and even the government are left with less money to spend.</p>
<p>The problem is that if rates rise too fast, the banking system can collapse. In my latest book <a href="https://link.springer.com/book/10.1007/978-3-031-11914-9">Calming the Storms: the Carry Trade, the Banking School and British Financial Crises Since 1825</a>, I discuss how all major financial crises in Britain over the past 200 years were triggered by excessively rapid rises in interest rates.</p>
<p>More recent near-misses include the market panic triggered by ex-prime minister Liz Truss’s ill-conceived mini-budget last autumn. Its unfunded tax cuts and proposed borrowing splurge caused a rapid rise in interest rates and brought Britain within 24 hours of a full-scale financial crisis. Thankfully, <a href="https://theconversation.com/only-a-u-turn-by-the-government-or-the-bank-of-england-will-calm-uk-financial-markets-191523">Truss u-turned on her policies</a>.</p>
<p>Likewise, the collapse of Silicon Valley Bank and the resulting US banking crisis last March was triggered by rising interest rates.</p>
<hr>
<p>
<em>
<strong>
Read more:
<a href="https://theconversation.com/silicon-valley-bank-how-interest-rates-helped-trigger-its-collapse-and-what-central-bankers-should-do-next-201697">Silicon Valley Bank: how interest rates helped trigger its collapse and what central bankers should do next</a>
</strong>
</em>
</p>
<hr>
<h2>How to avoid financial instability</h2>
<p>International economic institutions have also begun to wake up to the risks of rapid rate rises. The Bank for International Settlements – often referred to as central bankers’ central bank – has recently pushed for the use of tax rises and spending cuts as additional means of reducing inflation. </p>
<p>“It would reduce the need for monetary policy to keep interest rates higher for longer, thereby reducing the risk of financial instability,” stated its <a href="https://www.bis.org/publ/arpdf/ar2023e.pdf">2023 report on the global economy</a>, published June 25.</p>
<p>Likewise, the deputy head of the International Monetary Fund told the Financial Times on June 26 that central banks had to face the “<a href="https://www.ft.com/content/7d3276bb-8ef8-444c-8356-2792a6f58a24">uncomfortable truth</a>” that they might have to tolerate periods of above-2% inflation to avoid their interest rate rises triggering further financial instability. Bank of England governor Andrew Bailey has also recently indicated that inflation and interest rates <a href="https://www.theguardian.com/business/2023/jun/28/high-interest-rates-persist-bank-england-governor">may remain high for longer than expected</a>.</p>
<p>I outlined the case for the UK to tackle inflation using fiscal policy – that is, changes to tax and spending rather than interest rates alone – in a <a href="https://www.historyandpolicy.org/policy-papers/papers/reforming-the-bank-of-england-to-tame-inflation-and-boost-financial-stability-lessons-from-two-centuries-of-british-financial-history">policy paper delivered to HM Treasury last autumn</a>, before Truss’s mini-budget created market turmoil. I pointed out that rapid rises in interest rates to deal with inflation would cause a financial crisis in the shadow banking sector, which includes financial firms that don’t come under the stricter regulations of the mainstream banking sector.</p>
<p>Changes in fiscal policy – such as cuts to VAT, which would directly reduce prices – could help return inflation back to the Bank of England’s target without destabilising the banking sector. These could be paid for by axing tax reliefs enjoyed mainly by the wealthy, such as the discount for declaring income as capital gains instead of as income.</p>
<p>Such fiscal measures could re-anchor businesses’ and consumers’ expectations for future price rises at 2%. Rather than trying to cool the economy by pushing up the repayment costs of a relatively small number of mortgage holders, raising taxes would have instead shared the burden out more equally or equitably.</p>
<figure class="align-center ">
<img alt="Hand holding a copy of the Financial Times newspaper with image of Liz Truss and headline: " src="https://images.theconversation.com/files/534636/original/file-20230628-19349-qq0fe6.jpg?ixlib=rb-1.1.0&q=45&auto=format&w=754&fit=clip" srcset="https://images.theconversation.com/files/534636/original/file-20230628-19349-qq0fe6.jpg?ixlib=rb-1.1.0&q=45&auto=format&w=600&h=450&fit=crop&dpr=1 600w, https://images.theconversation.com/files/534636/original/file-20230628-19349-qq0fe6.jpg?ixlib=rb-1.1.0&q=30&auto=format&w=600&h=450&fit=crop&dpr=2 1200w, https://images.theconversation.com/files/534636/original/file-20230628-19349-qq0fe6.jpg?ixlib=rb-1.1.0&q=15&auto=format&w=600&h=450&fit=crop&dpr=3 1800w, https://images.theconversation.com/files/534636/original/file-20230628-19349-qq0fe6.jpg?ixlib=rb-1.1.0&q=45&auto=format&w=754&h=566&fit=crop&dpr=1 754w, https://images.theconversation.com/files/534636/original/file-20230628-19349-qq0fe6.jpg?ixlib=rb-1.1.0&q=30&auto=format&w=754&h=566&fit=crop&dpr=2 1508w, https://images.theconversation.com/files/534636/original/file-20230628-19349-qq0fe6.jpg?ixlib=rb-1.1.0&q=15&auto=format&w=754&h=566&fit=crop&dpr=3 2262w" sizes="(min-width: 1466px) 754px, (max-width: 599px) 100vw, (min-width: 600px) 600px, 237px">
<figcaption>
<span class="caption">Liz Truss resigned as prime minister after financial markets reacted badly to her plans for the UK economy.</span>
<span class="attribution"><a class="source" href="https://www.shutterstock.com/image-photo/london-england-october-21-male-hand-2268991003">Hadrian/Shutterstock</a></span>
</figcaption>
</figure>
<h2>Fiscal policy to the rescue?</h2>
<p>Unfortunately, this advice was ignored in Truss’s mini-budget. As a Conservative, she has a strong political aversion to raising direct taxes that might impact wealthy voters.</p>
<p>The appointment of Hunt as chancellor and then Rishi Sunak as prime minister following the ill-fated mini-budget resulted in most of its measures being reversed. This calmed markets, and interest rates fell back. Rather than considering more tax increases in this year’s budget, Hunt said <a href="https://www.independent.co.uk/tv/news/budget-inflation-economy-jeremy-hunt-b2301359.html">inflation would fall back</a> over the course of this year, thanks to falling energy and commodity prices.</p>
<p>But far from falling, <a href="https://www.ons.gov.uk/economy/inflationandpriceindices/bulletins/consumerpriceinflation/may2023#:%7E:text=The%20CPIH%20inflation%20rate%20is,down%20from%2010.0%25%20in%20April.">core inflation</a>, which excludes volatile food and energy costs, has risen from 5.1% to 7.1% between January and June this year.</p>
<p>Similarly, <a href="https://www.ons.gov.uk/employmentandlabourmarket/peopleinwork/employmentandemployeetypes/bulletins/averageweeklyearningsingreatbritain/june2023">annual wage growth</a> has risen to 7.2%, triggering a price-wage spiral. This happens when wage rises push up prices, which then pushes wages up, and so on. If fiscal and tax policy had been used to reinforce the 2% target last year, a wage-price spiral might have been avoided.</p>
<p>Sunak has promised to halve inflation from its peak by the end of the year, hoping this will give him enough support to win the next general election. But without more determined action by the government, the odds of Sunak’s gamble working out for him – and for UK mortgage borrowers – look ever longer.</p><img src="https://counter.theconversation.com/content/208697/count.gif" alt="The Conversation" width="1" height="1" />
<p class="fine-print"><em><span>Charles Read's research is funded by a British Academy postdoctoral fellowship grant.</span></em></p>Tax cuts could help reduce inflation without destabilising the banking sector and piling the pressure on mortgage holdersCharles Read, Fellow in Economics and History at Corpus Christi College, University of CambridgeLicensed as Creative Commons – attribution, no derivatives.tag:theconversation.com,2011:article/2081612023-06-28T15:02:19Z2023-06-28T15:02:19ZFive parts of the economy that are hit when house prices fall<figure><img src="https://images.theconversation.com/files/534359/original/file-20230627-29-xx1764.jpg?ixlib=rb-1.1.0&rect=49%2C33%2C5454%2C3622&q=45&auto=format&w=496&fit=clip" /><figcaption><span class="caption">People putting their houses up for sale are starting to see signs of falling prices.</span> <span class="attribution"><a class="source" href="https://www.shutterstock.com/image-photo/estate-agent-sale-sign-on-street-1787318480">William Barton/Shutterstock</a></span></figcaption></figure><p>UK house price growth is slowing. While <a href="https://www.zoopla.co.uk/discover/property-news/house-price-index/">prices rose 1.2% in June compared to last year</a>, this is down on May’s 1.9% growth, according to property website Zoopla. Its house price index – which forecasts a 5% fall in house prices this year – also shows that 42% of sellers are now accepting offers of more than 5% below asking price, the highest level since 2018.</p>
<p>This may be seen as a positive for first-time buyers who have been subject to steadily rising prices in recent years. But the Bank of England’s decision to <a href="https://theconversation.com/why-the-bank-of-englands-interest-rate-hikes-arent-slowing-inflation-enough-and-what-that-means-for-mortgages-208215">crank up interest rates</a> to combat inflation over the past year means that <a href="https://www.theguardian.com/money/2023/jun/26/two-and-five-year-fixed-rate-mortgages-in-uk-at-highest-level-for-seven-months">mortgage costs have been rising</a>. This is squeezing people’s affordability and offsetting some of the relief over falling prices. Indeed, mortgage borrowing has reached <a href="https://www.bankofengland.co.uk/statistics/money-and-credit/2023/april-2023">the lowest level on record</a> (excluding the period since the onset of the COVID pandemic), according to Bank of England data.</p>
<p>And still, inflation remains “sticky”. Although UK consumer price inflation slowed in April, it was higher than expected at 8.7% and <a href="https://www.ons.gov.uk/economy/inflationandpriceindices/bulletins/consumerpriceinflation/may2023">it remained at this rate in May</a>. More interest rate increases are expected to curb price growth and many lenders have been <a href="https://www.theguardian.com/money/2023/jun/05/mortgages-uk-lenders-continue-to-raise-rates-and-pull-deals">raising their mortgage interest rates</a> in anticipation, which drags down demand for housing. </p>
<hr>
<p>
<em>
<strong>
Read more:
<a href="https://theconversation.com/five-ways-to-reduce-your-mortgage-repayments-in-2023-and-why-rates-have-risen-so-high-196327">Five ways to reduce your mortgage repayments in 2023 – and why rates have risen so high</a>
</strong>
</em>
</p>
<hr>
<p>As long as <a href="https://journals.sagepub.com/doi/abs/10.1111/j.1467-856X.2009.00380.x?journalCode=bpia">inflation remains high</a>, financial markets will expect more base rate increases. This would almost certainly force further declines in UK house prices, with significant implications for all of our finances, because the health of the housing market affects the wider economy and financial stability. </p>
<p>Here are five ways falling house prices affect the economy:</p>
<h2>1. Homeowners, borrowers and mortgage lenders</h2>
<p>The most obvious victims of falling house prices are homeowners, but particularly those with mortgages. If the value of your property decreases, it reduces your equity. This is the amount of your mortgage that you’ve paid off – or the portion of your house that you now own, versus the loan amount you have left to repay.</p>
<p>This could potentially leave you in a negative equity situation, meaning you owe more to your mortgage lender than the value of your home. This was a particular problem after the global financial crisis and some people – called <a href="https://commonslibrary.parliament.uk/research-briefings/cbp-9411/">mortgage prisoners</a> – are still struggling to sell or refinance their property.</p>
<p>For first-time buyers, lower house prices may make homes more affordable, of course. But rapid price falls can create uncertainty and <a href="https://www.thisismoney.co.uk/money/mortgageshome/article-11408707/Should-time-buyers-delay-haggle-house-prices-fall.html">discourage potential buyers</a> from entering the market, if they expect further declines in the future.</p>
<hr>
<p>
<em>
<strong>
Read more:
<a href="https://theconversation.com/house-prices-are-falling-but-that-doesnt-mean-you-should-buy-now-heres-what-first-time-buyers-should-consider-207938">House prices are falling, but that doesn't mean you should buy now – here's what first-time buyers should consider</a>
</strong>
</em>
</p>
<hr>
<p>Mortgage lenders also face higher risks when house prices fall because the collateral for their loans – peoples’ homes – becomes less valuable. They may decide to <a href="https://www.mortgagesolutions.co.uk/news/2022/08/01/wealthy-borrowers-impacted-by-stricter-rules-as-lenders-more-cautious-brokers-say/">enforce stricter lending criteria</a> and higher interest rates to compensate for the increased risk they are taking on as a result. When this happens, borrowers can find it harder to secure favourable mortgage terms or even to obtain loans, because lenders have become more cautious.</p>
<h2>2. The construction industry</h2>
<p>A decline in house prices can also affect the construction industry because developers may slow down or postpone new construction projects due to reduced demand. </p>
<p>In March, the sharpest decline in the construction purchasing managers’ index (PMI) since May 2020 indicated a decrease in house building. Builders attributed this decline to <a href="https://www.theconstructionindex.co.uk/news/view/construction-output-expected-to-fall-significantly">a decrease in new housing projects</a> due to caution about rising interest rates. </p>
<p>Associated sectors, such as suppliers of building materials, real estate agents and architects may also experience knock on effects of less building activity, which in turn affects their revenues.</p>
<figure class="align-center ">
<img alt="" src="https://images.theconversation.com/files/534360/original/file-20230627-26-3gnaam.jpg?ixlib=rb-1.1.0&q=45&auto=format&w=754&fit=clip" srcset="https://images.theconversation.com/files/534360/original/file-20230627-26-3gnaam.jpg?ixlib=rb-1.1.0&q=45&auto=format&w=600&h=400&fit=crop&dpr=1 600w, https://images.theconversation.com/files/534360/original/file-20230627-26-3gnaam.jpg?ixlib=rb-1.1.0&q=30&auto=format&w=600&h=400&fit=crop&dpr=2 1200w, https://images.theconversation.com/files/534360/original/file-20230627-26-3gnaam.jpg?ixlib=rb-1.1.0&q=15&auto=format&w=600&h=400&fit=crop&dpr=3 1800w, https://images.theconversation.com/files/534360/original/file-20230627-26-3gnaam.jpg?ixlib=rb-1.1.0&q=45&auto=format&w=754&h=503&fit=crop&dpr=1 754w, https://images.theconversation.com/files/534360/original/file-20230627-26-3gnaam.jpg?ixlib=rb-1.1.0&q=30&auto=format&w=754&h=503&fit=crop&dpr=2 1508w, https://images.theconversation.com/files/534360/original/file-20230627-26-3gnaam.jpg?ixlib=rb-1.1.0&q=15&auto=format&w=754&h=503&fit=crop&dpr=3 2262w" sizes="(min-width: 1466px) 754px, (max-width: 599px) 100vw, (min-width: 600px) 600px, 237px">
<figcaption>
<span class="caption">Falling house prices can cause a slowdown in the construction industry, as well as related sectors.</span>
<span class="attribution"><a class="source" href="https://www.shutterstock.com/image-photo/roofer-77666830">sculpies/Shutterstock</a></span>
</figcaption>
</figure>
<h2>3. Consumer spending</h2>
<p>It’s <a href="https://www.bankofengland.co.uk/-/media/boe/files/quarterly-bulletin/2006/house-prices-and-consumer-spending.pdf">a complex relationship</a>, but broadly speaking falling house prices can dent consumer confidence and spending because homeowners may feel less wealthy and so reduce their discretionary spending. When people spend less it has a knock-on effect for the wider economy. </p>
<p>And, of course, this is the exact situation that the Bank of England is trying to bring about by raising interest rates. If people have less money to spend, demand for goods and services will come down and prices should follow, slowing price inflation.</p>
<p>Additionally, a slowdown in the housing market can lead to decreased economic activity, affecting industries such as home improvements, furniture and appliances. A <a href="https://www.jstor.org/stable/24911335">decline in house prices</a> during both 1990 and 2007 coincided with significant economic recessions: the 1991 recession and the 2007/2008 recession, respectively. </p>
<h2>4. Financial markets</h2>
<p>Financial institutions that invest in real estate may face losses if house prices decline. This is because they have exposure to real estate markets through funds such as real estate investment trusts (REITs) or if they hold mortgage-backed securities. This is an investment product that derives its value from a mortgage or a pool of mortgages. </p>
<p>If financial institutions see the value of such holdings drop, it could affect their ability to make other investments, affecting the amount of credit available to businesses and also to homeowners via banks.</p>
<h2>5. Public finances</h2>
<p>A decline in house prices can affect government revenue because of the property and transaction taxes it collects are based on less valuable properties. Stamp duty, for example, is <a href="https://www.gov.uk/stamp-duty-land-tax/residential-property-rates">based on a property’s value</a> and so would bring in less money for the government in a housing downturn.</p>
<p>The extent and duration of the effects of house price drops will depend on factors including the magnitude of the price decline and the overall health of the economy before and while prices are falling. While falling house prices present challenges, they may also create opportunities for first-time buyers or those looking to move up the property ladder, for example. Overall, a balanced and sustainable housing market is key to protecting the health of the economy.</p><img src="https://counter.theconversation.com/content/208161/count.gif" alt="The Conversation" width="1" height="1" />
<p class="fine-print"><em><span>Anandadeep Mandal does not work for, consult, own shares in or receive funding from any company or organisation that would benefit from this article, and has disclosed no relevant affiliations beyond their academic appointment.</span></em></p>Falling property prices affect much more than people’s wealth.Anandadeep Mandal, Associate professor in finance, University of BirminghamLicensed as Creative Commons – attribution, no derivatives.tag:theconversation.com,2011:article/2082152023-06-22T16:04:33Z2023-06-22T16:04:33ZWhy the Bank of England’s interest rate hikes aren’t slowing inflation enough and what that means for mortgages<p>Consumer price inflation <a href="https://www.ons.gov.uk/economy/inflationandpriceindices/timeseries/d7g7/mm23">stuck at 8.7%</a> in May, defying expectations of a slowdown and making a further rise in UK interest rates inevitable. </p>
<p>The May figures came out the day before the Bank of England’s Monetary Policy Committee (MPC) was due to meet to discuss changing the UK base rate. This sets the interest rates for borrowing by the government, businesses and banks – who then feed any increases through to borrowers such as people with mortgages.</p>
<p>A 13th consecutive rise in June had been expected for some time, because <a href="https://www.ons.gov.uk/economy/inflationandpriceindices/bulletins/consumerpriceinflation/may2023">the headline rate of inflation</a> has been well above its medium-term 2% target since mid-2021. At the risk of being accused of derailing the UK’s post-COVID economic recovery, MPC members’ main decision at the most recent meeting was not whether or not to hike rates, but by how much. </p>
<p>The latest <a href="https://www.bankofengland.co.uk/monetary-policy-summary-and-minutes/2023/june-2023">0.5% increase (to 5%)</a> represents a jump from previous 0.25% increments, showing their concern that inflation is becoming embedded in the economy.</p>
<hr>
<p>
<em>
<strong>
Read more:
<a href="https://theconversation.com/inflation-why-prices-look-likely-to-stay-high-in-the-uk-and-ireland-and-what-that-means-for-mortgages-207625">Inflation: why prices look likely to stay high in the UK and Ireland, and what that means for mortgages</a>
</strong>
</em>
</p>
<hr>
<p>By increasing rates, the central bank is engaging in “monetary tightening”, which is designed to reduce the level of demand for goods and services in the economy. Households are encouraged to pay down debts and channel more of their incomes into saving. Those who cannot reduce their borrowing must pay more for it, leaving less to spend on other things. </p>
<p>The knock-on effect of rate hikes on people’s mortgage costs could result in a <a href="https://www.theguardian.com/money/2023/jun/21/1-point-4m-uk-households-huge-hit-to-finances-mortgage-timebomb-payments-fifth-disposale-income">20% hit to the disposable incomes</a> of 1.4 million mortgage holders before the next election, according to the Institute of Fiscal Studies. The government also finds its own <a href="https://tradingeconomics.com/united-kingdom/government-bond-yield">debt costs going up</a>, curbing ministerial inclinations to spend more money. </p>
<hr>
<p>
<em>
<strong>
Read more:
<a href="https://theconversation.com/uk-bonds-are-in-meltdown-again-what-does-that-mean-for-pensions-expert-qanda-206533">UK bonds are in meltdown again – what does that mean for pensions? Expert Q&A</a>
</strong>
</em>
</p>
<hr>
<p>And so, this policy has obvious social costs. As well as ruling out any government help with this latest cost of living shock, it punishes those who have been <a href="https://www.jrf.org.uk/report/dragged-down-debt-millions-low-income-households-pulled-under-arrears-while-living-costs-rise">forced to borrow due to poverty</a>, as well as the better-off who chose to borrow to accumulate more assets. It also has longer-term economic costs, <a href="https://www.bankofengland.co.uk/quarterly-bulletin/2021/2021-q2/influences-on-investment-by-uk-businesses-evidence-from-the-decision-maker-panel">deterring firms from borrowing for investment</a>. </p>
<p>But the MPC believes it has no alternative. Although volatile items, especially food, can be blamed for some of the current overshoot, core inflation (which removes these fluctuating items) has risen to a <a href="https://tradingeconomics.com/united-kingdom/core-inflation-rate">31-year high of 7.1%</a>. </p>
<p>For monetary policymakers, the fear is that, if they don’t act decisively now, inflation will become built into firms’ expectations when setting prices, as well as those of employees bargaining over wages. Such self-fulfilling expectations are blamed by many for a “<a href="https://ukandeu.ac.uk/stagflation-the-return-of-an-unwelcome-monster/">wage-price spiral</a>” that created a decade-long period of inflation and stagnation in the UK following the <a href="https://obr.uk/box/the-changing-impact-of-fossil-fuel-shocks-on-the-uk-economy/">oil price shocks of 1973</a>. </p>
<p>The number of rate increases since 2021 reflects an unexpected slowness for these hikes to take effect on inflation. Although a painfully blunt instrument in this respect, interest rates are the only one the MPC has. </p>
<h2>A convenient scapegoat</h2>
<p>The government has <a href="https://news.sky.com/story/cost-of-living-on-me-personally-if-inflation-isnt-halved-says-rishi-sunak-12898285">pledged to halve inflation</a> by year-end and is now in danger of breaking this promise. It’s convenient, then, to allow the <a href="https://www.telegraph.co.uk/business/2023/06/21/recession-inevitable-bank-of-england-lost-control-inflation/">blame for overshooting inflation</a> to be placed on the independent central bank. </p>
<p>With hindsight, the Bank of England’s <a href="https://www.bankofengland.co.uk/explainers/what-are-interest-rates#:%7E:text=That%20includes%20the%20lending%20and,Bank%20Rate%20is%20currently%204.5%25.">policy since the 2008 global financial crisis</a> is easy to criticise. It kept interest rates close to zero from February 2009 to March 2020, reducing them further during the COVID pandemic, then lifting them rapidly since December 2021. </p>
<p><strong>Base rate changes: 2006-2023</strong></p>
<figure class="align-center zoomable">
<a href="https://images.theconversation.com/files/533230/original/file-20230621-27-naqm9v.png?ixlib=rb-1.1.0&q=45&auto=format&w=1000&fit=clip"><img alt="Line chart showing the base rate at nearly 6% in 2008 before dropping below 1% until 2021 when it started rising again to reach 4.5% in May 2023." src="https://images.theconversation.com/files/533230/original/file-20230621-27-naqm9v.png?ixlib=rb-1.1.0&q=45&auto=format&w=754&fit=clip" srcset="https://images.theconversation.com/files/533230/original/file-20230621-27-naqm9v.png?ixlib=rb-1.1.0&q=45&auto=format&w=600&h=345&fit=crop&dpr=1 600w, https://images.theconversation.com/files/533230/original/file-20230621-27-naqm9v.png?ixlib=rb-1.1.0&q=30&auto=format&w=600&h=345&fit=crop&dpr=2 1200w, https://images.theconversation.com/files/533230/original/file-20230621-27-naqm9v.png?ixlib=rb-1.1.0&q=15&auto=format&w=600&h=345&fit=crop&dpr=3 1800w, https://images.theconversation.com/files/533230/original/file-20230621-27-naqm9v.png?ixlib=rb-1.1.0&q=45&auto=format&w=754&h=433&fit=crop&dpr=1 754w, https://images.theconversation.com/files/533230/original/file-20230621-27-naqm9v.png?ixlib=rb-1.1.0&q=30&auto=format&w=754&h=433&fit=crop&dpr=2 1508w, https://images.theconversation.com/files/533230/original/file-20230621-27-naqm9v.png?ixlib=rb-1.1.0&q=15&auto=format&w=754&h=433&fit=crop&dpr=3 2262w" sizes="(min-width: 1466px) 754px, (max-width: 599px) 100vw, (min-width: 600px) 600px, 237px"></a>
<figcaption>
<span class="caption">The Bank of England base rate, 2006-2023.</span>
<span class="attribution"><a class="source" href="https://www.bankofengland.co.uk/explainers/what-are-interest-rates#:~:text=That%20includes%20the%20lending%20and,Bank%20Rate%20is%20currently%204.5%25.">Bank of England</a></span>
</figcaption>
</figure>
<p>The long phase of ultra-low interest rates deterred households and firms from paying down the debts that underlay the 2008 crisis. So the unprecedented jump in interest rates since 2021 has caused a sudden shock to corporate and household cashflows. Even now, many mortgage borrowers are <a href="https://www.mirror.co.uk/money/martin-lewis-says-mortgage-timebomb-30282073">still waiting to feel the full force</a>. </p>
<p>When this does happen, the rise in borrowing costs – on top of the surge in other living costs – could tip an already slow-growing economy back into full-blown recession. That would be compounded if, as in the <a href="https://www.bankofengland.co.uk/-/media/boe/files/quarterly-bulletin/1995/the-housing-market-and-the-economy.pdf">early 1990s</a>, falling house prices knock a further hole in the finances of UK homeowners. </p>
<p>But it could also be argued that the post-2008 decade of low interest rates was unavoidable. Governments and business needed to borrow at low cost to haul the economy out of the deep 2009-2010 recession. During this time, inflation was close to zero and any lasting fall in consumer prices could have created a further slump. </p>
<p>The sharp interest-rate rise since 2021 has been equally unavoidable. As well as restraining inflation, it is needed to attract foreign investment to finance the UK’s <a href="https://www.ons.gov.uk/economy/nationalaccounts/balanceofpayments/bulletins/balanceofpayments/octobertodecember2022">persistent current-account deficits</a>. </p>
<p>These used to be comfortably financed by foreign direct investment (FDI), which offset the UK’s excess of imports over exports. But FDI has <a href="https://commonslibrary.parliament.uk/research-briefings/cbp-8534/">tailed downwards</a> since the 2016 Brexit vote. </p>
<p>So external financing now relies more heavily on foreign financial investors, who are looking for a higher return – as is evident from the rising yield the government must pay on its <a href="https://www.ft.com/content/04b15997-c4a3-4ad1-9244-db0fbb68b537">own borrowing</a>. </p>
<figure class="align-center ">
<img alt="A long exposure capturing the traffic trails at a busy junction at night." src="https://images.theconversation.com/files/533245/original/file-20230621-3894-nhy5sj.jpg?ixlib=rb-1.1.0&q=45&auto=format&w=754&fit=clip" srcset="https://images.theconversation.com/files/533245/original/file-20230621-3894-nhy5sj.jpg?ixlib=rb-1.1.0&q=45&auto=format&w=600&h=338&fit=crop&dpr=1 600w, https://images.theconversation.com/files/533245/original/file-20230621-3894-nhy5sj.jpg?ixlib=rb-1.1.0&q=30&auto=format&w=600&h=338&fit=crop&dpr=2 1200w, https://images.theconversation.com/files/533245/original/file-20230621-3894-nhy5sj.jpg?ixlib=rb-1.1.0&q=15&auto=format&w=600&h=338&fit=crop&dpr=3 1800w, https://images.theconversation.com/files/533245/original/file-20230621-3894-nhy5sj.jpg?ixlib=rb-1.1.0&q=45&auto=format&w=754&h=424&fit=crop&dpr=1 754w, https://images.theconversation.com/files/533245/original/file-20230621-3894-nhy5sj.jpg?ixlib=rb-1.1.0&q=30&auto=format&w=754&h=424&fit=crop&dpr=2 1508w, https://images.theconversation.com/files/533245/original/file-20230621-3894-nhy5sj.jpg?ixlib=rb-1.1.0&q=15&auto=format&w=754&h=424&fit=crop&dpr=3 2262w" sizes="(min-width: 1466px) 754px, (max-width: 599px) 100vw, (min-width: 600px) 600px, 237px">
<figcaption>
<span class="caption">The Bank of England building (left) in the City of London.</span>
<span class="attribution"><a class="source" href="https://www.shutterstock.com/image-photo/long-exposure-capturing-traffic-trails-busy-2186057577">Jason Wells/Shutterstock</a></span>
</figcaption>
</figure>
<h2>Treatment-resistant inflation</h2>
<p>Although inevitable, the recent succession of interest rate rises has done little to tame the inflation we’re all experiencing at the moment. </p>
<p>Since early 2022, most prices have been pushed up by rising costs, which is known as <a href="https://www.investopedia.com/terms/c/costpushinflation.asp">cost-push inflation</a>. Raw material costs have been fuelled by the global rise in food and energy prices, and last autumn’s steep <a href="https://www.goldmansachs.com/intelligence/pages/why-the-british-pound-fell-to-a-record-low-against-the-us-dollar.html">depreciation of the pound against the US dollar</a>. Rising wage costs are an inevitable result of widespread labour shortages, exacerbated in the UK by a <a href="https://obr.uk/box/the-impact-of-the-pandemic-on-labour-market-participation/">post-COVID fall in workforce numbers</a> and the <a href="https://www.ecb.europa.eu/pub/economic-bulletin/articles/2023/html/ecb.ebart202303_01%7E3af23c5f5a.en.html">loss of EU workers</a> since Brexit.</p>
<p>With the government’s own borrowing costs climbing back towards the level that triggered fiscal meltdown after <a href="https://www.niesr.ac.uk/wp-content/uploads/2022/12/NIESR-Term-Premia-Tracker-Dec-2022.pdf">last September’s Truss budget</a>, it now risks a further <a href="https://www.santander.com/en/stories/what-is-stagflation#:%7E:text=%E2%80%9CStagflation%E2%80%9D%20is%20a%20combination%20of,less%20bang%20for%20your%20buck.">stagflationary spiral</a> – a combination of high inflation and an economy in recession. Rising interest rates are likely to divert more budget spending from growth-promoting projects into servicing public debt.</p>
<p>But if mortgage borrowers get any short-term relief from rising rates, it will only be in the <a href="https://www.reuters.com/world/uk/uks-hunt-says-mortgage-holders-should-not-expect-financial-help-2023-06-20/">unlikely event</a> that the shock from the <a href="https://www.bankofengland.co.uk/monetary-policy-summary-and-minutes/2023/june-2023">latest rate rise</a> to 5% prompts emergency action to avert a pre-election recession.</p><img src="https://counter.theconversation.com/content/208215/count.gif" alt="The Conversation" width="1" height="1" />
<p class="fine-print"><em><span>Alan Shipman does not work for, consult, own shares in or receive funding from any company or organisation that would benefit from this article, and has disclosed no relevant affiliations beyond their academic appointment.</span></em></p>Interest rate hikes are the Bank of England’s main monetary policy weapon against inflation, but they aren’t working.Alan Shipman, Senior Lecturer in Economics, The Open UniversityLicensed as Creative Commons – attribution, no derivatives.tag:theconversation.com,2011:article/2076252023-06-15T12:52:01Z2023-06-15T12:52:01ZInflation: why prices look likely to stay high in the UK and Ireland, and what that means for mortgages<figure><img src="https://images.theconversation.com/files/532031/original/file-20230614-23-ee7899.jpg?ixlib=rb-1.1.0&rect=80%2C44%2C5874%2C3943&q=45&auto=format&w=496&fit=clip" /><figcaption><span class="caption">Counting the cost of rising prices.</span> <span class="attribution"><a class="source" href="https://www.shutterstock.com/image-photo/young-woman-label-on-pasta-package-2136267077">Drazen Zigic/Shutterstock</a></span></figcaption></figure><p>The European Central Bank (ECB) has raised its three key interest rates by 0.25% to their highest levels in more than 20 years. The ECB’s “main refinancing rate” which dictates the cost of borrowing across much of Europe, including for people with tracker mortgages in Ireland, <a href="https://www.ecb.europa.eu/press/pr/date/2023/html/ecb.mp230615%7Ed34cddb4c6.en.html#:%7E:text=of%20July%202023.-,Key%20ECB%20interest%20rates,-The%20Governing%20Council">will rise from 3.75% to 4%</a> in June 2023. The governor of the Central Bank of Ireland has already said <a href="https://www.reuters.com/markets/rates-bonds/ecbs-makhlouf-says-rates-will-not-fall-quickly-peak-2023-06-07/">another increase next month</a> is “probable”. </p>
<p>When making decisions about interest rate changes, central bank officials keep a close eye on price inflation figures because they use rate changes to slow the flow of money into the economy. This is supposed to control rising prices by curbing demand for goods and services. Budgets are tighter so people buy less, or so the theory goes. </p>
<p>ECB president Christine Lagarde <a href="https://www.ecb.europa.eu/press/key/date/2023/html/ecb.sp230605%7E0aadd43ce7.en.html">warned in early June</a> that “price pressures remain strong … underlying inflationary pressures remain high … and there is no clear evidence that underlying inflation has peaked”. And UK chancellor <a href="https://www.bbc.co.uk/news/business-65891838">Jeremy Hunt recently said</a> there is “no alternative” to using rate hikes to control the UK’s “number one challenge” right now: inflation. </p>
<p><a href="https://www.itv.com/watch/news/former-bank-of-england-governor-says-interest-rates-will-rise-for-the-foreseeable-future/50l70mx">Economic experts</a>, as well as <a href="https://uk.finance.yahoo.com/news/interest-rates-markets-expect-hike-uk-core-inflation-remains-high-094506530.html">financial market participants</a>, are also betting that the UK will continue to raise interest rates this year to try to beat back inflation. Major mortgage lenders have been <a href="https://www.theguardian.com/money/2023/jun/12/uk-mortgage-turmoil-continues-as-santander-pulls-deals-for-new-borrowers">pulling their deals with the lowest rates</a> in anticipation of these base rate hikes, which will raise the cost of borrowing even further. </p>
<p>As well as increases in mortgage repayments, rapidly rising inflation has exacerbated a cost of living crisis in the UK that has seen people struggle to heat their homes over the past year. Food prices have also shot up relative to other countries in Europe, adding to these financial concerns.</p>
<p>Even more worryingly, a recent trend in the inflation figures for the UK and Ireland indicates these high prices may have become embedded in both economies. This means that, rather than quickly falling back to “normal” levels, recent high price levels might become permanent.</p>
<h2>Inflation pressures</h2>
<p>As in many other countries, inflation rose substantially in Ireland during 2021 and 2022 and has remained high so far in 2023. Having fallen to 0% during the COVID pandemic, Ireland’s <a href="https://www.cso.ie/en/releasesandpublications/er/cpi/consumerpriceindexdecember2021/">main rate of consumer price inflation</a> (CPI) – the headline rate – began to rise in mid-2021, reaching 5.5% by the end of 2021, followed by <a href="https://www.cso.ie/en/releasesandpublications/ep/p-cpi/consumerpriceindexoctober2022/">a peak of 9.2%</a> in October 2022. </p>
<p>Inflation has decreased somewhat since then, falling to <a href="https://www.cso.ie/en/releasesandpublications/ep/p-cpi/consumerpriceindexmay2023/">6.6% in the year to May 2023</a> in Ireland. But while this headline inflation rate has fallen back somewhat, consumer prices are still rising well above the ECB’s <a href="https://www.ecb.europa.eu/mopo/html/index.en.html">2% inflation target</a>.</p>
<p>In addition to this headline rate, economists and central bankers often look at what’s called the “core” inflation rate. This is a measure of price inflation that excludes items that tend to see the most price volatility each month. There is no shared definition among countries of which items should be excluded, but it’s usually energy and food, and sometimes tobacco and alcohol.</p>
<p>By stripping out things that are more prone to rapid price changes, the core inflation figure shows the underlying price rises that are expected to persist in the medium or long term. Since the headline rate includes the volatile items, it is a better measure of shorter-term economic changes – for example, when energy prices spiked after Russia invaded Ukraine last year, then <a href="https://www.resolutionfoundation.org/publications/the-only-way-is-down/">started to fall again</a> last winter and into 2023. </p>
<h2>Core versus headline rates of inflation</h2>
<p>When inflation is low, stable and close to the central bank’s 2% target, this core rate doesn’t tend to get much attention. But since inflation began to rise significantly during 2021, interest in core inflation has grown because the figure strips out the noise of fast-changing costs such as energy. This measure therefore indicates if prices rises have become embedded in the economy – that is, if they are here to stay. </p>
<p>Recent <a href="https://www.cso.ie/en/releasesandpublications/ep/p-cpi/consumerpriceindexmay2023/">figures published by Ireland’s Central Statistics Office (CSO)</a> showed the country’s headline rate of inflation has fallen from a peak of 9.2% in October 2022 to 6.6% in May 2023. At the same time, CPI excluding energy and unprocessed food – a proxy for core inflation – rose from 5% in the year to December 2022 to 6.8% in the year to May 2023. </p>
<p>This puts Ireland’s core rate above its headline rate for the first time in more than two years. This has happened because a sharp fall in energy prices (14.6% for petrol and 22.9% for diesel) dragged down the headline rate of inflation – even though this was tempered by a sharp spike in food price inflation, from 2% to 10% over the course of 2022. But these items are not included in calculations for the core rate of inflation, which explains why Ireland’s headline rate has fallen below its core rate. </p>
<figure class="align-center ">
<img alt="A coloured map of the UK and Ireland." src="https://images.theconversation.com/files/532032/original/file-20230614-20396-zff5s3.jpg?ixlib=rb-1.1.0&q=45&auto=format&w=754&fit=clip" srcset="https://images.theconversation.com/files/532032/original/file-20230614-20396-zff5s3.jpg?ixlib=rb-1.1.0&q=45&auto=format&w=600&h=400&fit=crop&dpr=1 600w, https://images.theconversation.com/files/532032/original/file-20230614-20396-zff5s3.jpg?ixlib=rb-1.1.0&q=30&auto=format&w=600&h=400&fit=crop&dpr=2 1200w, https://images.theconversation.com/files/532032/original/file-20230614-20396-zff5s3.jpg?ixlib=rb-1.1.0&q=15&auto=format&w=600&h=400&fit=crop&dpr=3 1800w, https://images.theconversation.com/files/532032/original/file-20230614-20396-zff5s3.jpg?ixlib=rb-1.1.0&q=45&auto=format&w=754&h=503&fit=crop&dpr=1 754w, https://images.theconversation.com/files/532032/original/file-20230614-20396-zff5s3.jpg?ixlib=rb-1.1.0&q=30&auto=format&w=754&h=503&fit=crop&dpr=2 1508w, https://images.theconversation.com/files/532032/original/file-20230614-20396-zff5s3.jpg?ixlib=rb-1.1.0&q=15&auto=format&w=754&h=503&fit=crop&dpr=3 2262w" sizes="(min-width: 1466px) 754px, (max-width: 599px) 100vw, (min-width: 600px) 600px, 237px">
<figcaption>
<span class="caption"></span>
<span class="attribution"><span class="source">Ulf Wittrock/Shutterstock</span></span>
</figcaption>
</figure>
<h2>UK inflation</h2>
<p>This shift has not happened in the UK yet, but it could soon. The headline rate of CPI for Britain reached a peak above 11% in October 2022, and has since declined to <a href="https://www.ons.gov.uk/economy/inflationandpriceindices/bulletins/consumerpriceinflation/april2023">8.7% in the year to April 2023</a>. </p>
<p>Falling electricity and gas prices, as well as decreases in liquid fuels such as petrol, contributed to this headline rate slowdown. But the UK’s core inflation has not fallen because it does not include energy – and in fact has increased somewhat during 2023, reaching 6.8% in the year to April. The UK has experienced even higher inflation in food and non-alcoholic beverage prices than Ireland, seeing a staggering 19% annual rise in early 2023.</p>
<p>The UK’s headline rate of inflation remains about 1.5%-2% above the core rate – but it is moving in the same direction as Ireland, so could yet be overtaken by the core rate. This would alert the Bank of England that high prices are in danger of becoming embedded in the economy, and that it needs to take more action to bring them down.</p>
<p>Since central banks use inflation figures to set their interest rates, this means people in both the UK and Ireland could see things like mortgage payments continue to increase, further fuelling the cost of living crisis.</p><img src="https://counter.theconversation.com/content/207625/count.gif" alt="The Conversation" width="1" height="1" />
<p class="fine-print"><em><span>Stephen McNena does not work for, consult, own shares in or receive funding from any company or organisation that would benefit from this article, and has disclosed no relevant affiliations beyond their academic appointment.</span></em></p>Different rates of inflation indicate high prices have become ‘embedded’ in these economies.Stephen McNena, Economics lecturer, University of GalwayLicensed as Creative Commons – attribution, no derivatives.tag:theconversation.com,2011:article/2065832023-06-01T12:10:22Z2023-06-01T12:10:22ZWhy UK inflation is so high compared to EU and US and what to do about it<figure><img src="https://images.theconversation.com/files/529401/original/file-20230531-29-mth44s.jpg?ixlib=rb-1.1.0&rect=107%2C62%2C5865%2C3889&q=45&auto=format&w=496&fit=clip" /><figcaption><span class="caption">Price rises are slowing but inflation remains persistent.</span> <span class="attribution"><a class="source" href="https://www.shutterstock.com/image-photo/rising-cost-living-inflation-financial-crisis-2164240561">Ink Drop/Shutterstock</a></span></figcaption></figure><p>Britain has a bigger inflation problem than either the US or the eurozone, according to <a href="https://www.reuters.com/world/uk/uk-has-bigger-core-inflation-problem-than-other-economies-boes-mann-2023-05-31/">Bank of England policymaker Catherine Mann</a>. </p>
<p>The latest official UK inflation figures show UK price rises have slowed from double digits to <a href="https://www.ons.gov.uk/economy/inflationandpriceindices">8.7%</a> for the 12 months to April 2023. But this is still above the <a href="https://www.morningstar.co.uk/uk/news/235505/no-let-up-for-boe-as-uk-inflation-figures-mixed.aspx">8.2% rate forecast by the Bank of England earlier this year</a>. </p>
<p>The UK rate is also nearly double <a href="https://www.bls.gov/news.release/cpi.nr0.htm">the equivalent US rate</a> and significantly <a href="https://www.reuters.com/markets/europe/inflation-dips-german-states-pointing-national-drop-2023-05-31/%22%22">higher than the eurozone’s 7% rate of inflation for April</a>, which slowed <a href="https://www.ecb.europa.eu/stats/macroeconomic_and_sectoral/hicp/html/index.en.html">to 6.1% for May</a>.</p>
<p>All three regions experienced the economic shock of the COVID-19 pandemic. EU countries and the UK struggled with dramatically rising energy prices due to Russia’s war in Ukraine. But two UK-specific issues are exacerbating the country’s inflation woes: the adverse <a href="https://theconversation.com/price-inflation-five-ways-stronger-uk-supply-chains-can-help-reduce-rising-food-costs-206039">economic shock of Brexit</a>, and the UK’s reliance on its financial services sector.</p>
<p>As a result, interest rate rises by the Bank of England will not be enough to reduce inflation. The UK government should also play a role by <a href="https://journals.lwbooks.co.uk/soundings/vol-2012-issue-50/abstract-7344/">rebalancing the post-Brexit economy</a> away from financial services towards other traditional industries such as manufacturing.</p>
<p>Interest rates are a <a href="https://www.standard.co.uk/comment/bank-of-england-interest-rates-inflation-andrew-bailey-b1069517.html">blunt instrument</a> for fighting inflation, but they continue to be <a href="https://www.imf.org/en/Blogs/Articles/2022/08/10/central-banks-hike-interest-rates-in-sync-to-tame-inflation-pressures">central banks’ main tool</a>. They <a href="https://theconversation.com/bank-of-england-interest-rate-rise-why-this-could-be-the-last-increase-for-a-while-205337">affect the economy</a> in several ways. The most obvious is in reducing demand for goods and services by increasing the cost of different forms of debt (such as mortgages).</p>
<hr>
<p>
<em>
<strong>
Read more:
<a href="https://theconversation.com/why-you-should-care-about-bumper-bank-profits-201440">Why you should care about bumper bank profits</a>
</strong>
</em>
</p>
<hr>
<p>But interest rates also affect whether businesses can meet their debt repayments and reduce the <a href="https://www.jstor.org/stable/40268893">value of the collateral</a> they provide to banks to secure their loans. This weighs on banks’ balance sheets and so interest rate increases adversely affect the financial sector because it there is a greater risk that these borrowers won’t be able to repay their loans. This is why an oversized financial sector creates headaches for the Bank of England when it tries to tackle inflation.</p>
<h2>The UK’s industrial past</h2>
<p>In the 1950s, the UK had a balanced economy <a href="https://www.tandfonline.com/doi/full/10.1080/13504851.2012.684773">more evenly distributed between manufacturing and the service sector</a>. Manufacturing (including gas, electricity and water utilities) contributed over 40% of <a href="https://www.bankofengland.co.uk/explainers/how-has-growth-changed-over-time">total UK economic output in the 1950s</a> while the service sector accounted for 50%. The UK was responsible for a <a href="https://www.le.ac.uk/ur/emoha/community/resources/postwar/Britain%20in%201950.pdf">quarter of world trade in manufacturing</a>. </p>
<p>The government of the day <a href="https://www.ecb.europa.eu/pub/pdf/scpwps/ecb.wp2580%7Ef3ec872727.en.pdf">prioritised production for export</a>, making the UK a <a href="https://www.jstor.org/stable/2123398">leading shipbuilder</a>, and a European hub for producing <a href="https://edition.cnn.com/2023/01/25/cars/uk-car-production/index.html">cars</a>, <a href="https://manchesterhistorian.com/2013/the-rise-and-fall-of-the-british-coal-industry/">coal</a>, <a href="https://www.bbc.co.uk/news/business-36337180">steel</a> and <a href="https://dro.dur.ac.uk/18175/">textiles</a> to sell to other countries. Science-based industries, such as electronics, computers and engineering were also taking off in the UK, and the country benefited from this <a href="https://www.economist.com/leaders/2012/04/21/the-third-industrial-revolution">third technology revolution</a>.</p>
<p>But advances in science-based industries did not happen soon enough to balance out a collapse in employment in manufacturing in the UK from the 1960s onwards. By 2011 around 80% of British workers were in service industries and <a href="https://www.ons.gov.uk/economy/economicoutputandproductivity/output/articles/fivefactsabouttheukservicesector/2016-09-29#:%7E:text=In%201841%20most%20people%20worked,and%20around%2010%25%20in%20manufacturing.">only 10% in manufacturing</a>. Various factors explain this decline in manufacturing jobs, including routine jobs being replaced by robots and computerised systems, rising imports from China and other emerging countries, and government policy. </p>
<p>In the 1970s, the government championed economic policies geared towards a housing boom and the financial hub of <a href="https://www.theguardian.com/business/2011/nov/16/why-britain-doesnt-make-things-manufacturing">the City of London</a>. The British public were told their future lay in working with their brains <a href="https://www.gresham.ac.uk/watch-now/sir-keith-joseph-and-market-economy">and not their hands</a>. De-industrialisation policies were instigated by UK prime minister <a href="https://journals.lwbooks.co.uk/soundings/vol-2012-issue-50/abstract-7344/">Margaret Thatcher and continued under Tony Blair and David Cameron</a>. </p>
<p>These policies were presented as economic modernisation that would improve workers wages and society as a whole. Even the Labour government, <a href="https://www.economist.com/bagehots-notebook/2018/07/06/labour-is-no-longer-the-party-of-the-traditional-working-class">traditionally associated with the working class</a>, was convinced the future lay in the <a href="https://www.oecd.org/naec/THE-KNOWLEDGE-ECONOMY.pdf">knowledge economy</a> and embarked on making Britain a global service provider.</p>
<figure class="align-center ">
<img alt="London's financial district skyline behind Southwark Bridge over the River Thames" src="https://images.theconversation.com/files/529403/original/file-20230531-19-8lir9y.jpg?ixlib=rb-1.1.0&q=45&auto=format&w=754&fit=clip" srcset="https://images.theconversation.com/files/529403/original/file-20230531-19-8lir9y.jpg?ixlib=rb-1.1.0&q=45&auto=format&w=600&h=400&fit=crop&dpr=1 600w, https://images.theconversation.com/files/529403/original/file-20230531-19-8lir9y.jpg?ixlib=rb-1.1.0&q=30&auto=format&w=600&h=400&fit=crop&dpr=2 1200w, https://images.theconversation.com/files/529403/original/file-20230531-19-8lir9y.jpg?ixlib=rb-1.1.0&q=15&auto=format&w=600&h=400&fit=crop&dpr=3 1800w, https://images.theconversation.com/files/529403/original/file-20230531-19-8lir9y.jpg?ixlib=rb-1.1.0&q=45&auto=format&w=754&h=503&fit=crop&dpr=1 754w, https://images.theconversation.com/files/529403/original/file-20230531-19-8lir9y.jpg?ixlib=rb-1.1.0&q=30&auto=format&w=754&h=503&fit=crop&dpr=2 1508w, https://images.theconversation.com/files/529403/original/file-20230531-19-8lir9y.jpg?ixlib=rb-1.1.0&q=15&auto=format&w=754&h=503&fit=crop&dpr=3 2262w" sizes="(min-width: 1466px) 754px, (max-width: 599px) 100vw, (min-width: 600px) 600px, 237px">
<figcaption>
<span class="caption">The City of London.</span>
<span class="attribution"><a class="source" href="https://www.shutterstock.com/image-photo/london-england-uk-29-january-2022-2115510095">Richard M Lee/Shutterstock</a></span>
</figcaption>
</figure>
<p>The rise of the <a href="https://www.investopedia.com/how-london-became-the-world-s-financial-hub-4589324">City of London</a>, and the finance, insurance, and real estate industries, under both Conservative and Labour governments has <a href="https://sirc.rbi.org.in/downloads/4Cecchetti.pdf">changed the economic trajectory of Britain</a>. For example, the City has sucked the best-educated people out of other regions and careers and into high-salaried London-based jobs. People who might have become scientists or engineers became bankers or hedge fund managers instead. </p>
<p>So, even though the City <a href="https://www.cityoflondon.gov.uk/supporting-businesses/economic-research/research-publications/city-statistics-briefing#:%7E:text=The%20City%20drives%20the%20economy,1.1bn%20in%20business%20rates.&text=There%20are%20587%2C000%20workers%20in,in%20every%2054%20GB%20workers.">generates £85 billion per year and employs over 580,000 people</a>, it is not a goose that lays Britain’s golden eggs but rather <a href="https://taxjustice.net/press/press-release-city-of-london-costs-uk-4-5tn-in-lost-economic-growth/">a cuckoo in the nest</a>. It has crowded out other sectors that traditionally allowed the whole country to prosper. </p>
<p>And the UK financial sector is now causing another problem: its dominance has made it more difficult for the Bank of England to control inflation because of the concerns about how higher interest rates will weigh on bank balance sheets.</p>
<hr>
<p>
<em>
<strong>
Read more:
<a href="https://theconversation.com/bank-of-england-interest-rate-rise-why-this-could-be-the-last-increase-for-a-while-205337">Bank of England interest rate rise: why this could be the last increase for a while</a>
</strong>
</em>
</p>
<hr>
<h2>Tackling ‘stubborn’ inflation</h2>
<p>This is why <a href="https://www.bankofengland.co.uk/monetary-policy">monetary policy</a> alone will not be able to tame UK inflation. The bank has <a href="https://www.ft.com/content/b972f5e3-4f03-4986-890d-5443878424ac">spoken about the difficulties it has faced</a> in anticipating the recent rise and persistence of inflation. But <a href="https://www.sciencedirect.com/science/article/pii/S1090944318301820?casa_token=FWqKQte81WkAAAAA:xeZAgbTCJALIb-WqzKEEl8s9vsPz_vhgXxpmmsV5r8ljkqK1nDxIJgJIsdZ3gFp66gd8OArszQ">advancements in statistical techniques</a> and <a href="https://onlinelibrary.wiley.com/doi/full/10.1002/for.2948?casa_token=met-fSTcdroAAAAA%3A7SoLcPMZnYgZkuPU-00wW-4j2D_yyEG-MTzjHzvbsjpuPeHv0yMibBVxX7pkpAqApCd4Nvirk5UB0II">computation power</a> have improved the ability to forecast inflation. On the other hand, unexpected government policies and the structure of the UK economy may have presented more of a challenge.</p>
<p>The bank’s models had little chance to account for the political turmoil and strategy changes resulting from Brexit. For example, <a href="https://committees.parliament.uk/committee/445/eu-goods-subcommittee/news/153116/trade-in-goods-significantly-harder-under-brexit-deal/">trade has become significantly more difficult</a> between the UK and EU following Brexit, reducing supply and pushing up prices. There are also <a href="https://www.ft.com/content/674525e8-ce3e-42aa-b5d1-36260d17179a">more people from the EU leaving than arriving in the UK</a>, putting pressure on wages in particular sectors and adding to the inflation problem. </p>
<p>Brexit, coupled with the oversized UK financial sector, makes the Bank of England’s job of controlling inflation so much harder. The government needs to rebalance the UK economy, with science-based industries playing an important role. This would ensure the Bank of England could adjust interest rates to tackle inflation, without having to worry about how it affects the over-sized financial services sector.</p><img src="https://counter.theconversation.com/content/206583/count.gif" alt="The Conversation" width="1" height="1" />
<p class="fine-print"><em><span>The authors do not work for, consult, own shares in or receive funding from any company or organisation that would benefit from this article, and have disclosed no relevant affiliations beyond their academic appointment.</span></em></p>UK inflation has been stubbornly high and interest rate hikes have not yet brought it in line with other advanced economies.Edward Thomas Jones, Lecturer in Economics / Director of the Institute of European Finance, Bangor UniversityYener Altunbas, Professor of Banking, Bangor UniversityLicensed as Creative Commons – attribution, no derivatives.tag:theconversation.com,2011:article/2065332023-05-26T15:34:26Z2023-05-26T15:34:26ZUK bonds are in meltdown again – what does that mean for pensions? Expert Q&A<p><em>UK government debt prices have taken an unnerving journey south in the past few days. The closely watched ten-year bond has now hit a yield of 4.3%, taking it within a fraction of the level that caused a crisis in autumn 2022.</em> </p>
<p><em>The cause that time was Liz Truss’s mini-budget, which investors decided jeopardised the public finances, prompting them to dump UK government bonds so aggressively that leading pensions funds were <a href="https://theconversation.com/how-bonds-work-and-why-everyone-is-talking-about-them-right-now-a-finance-expert-explains-191550">in danger</a> of collapse until the Bank of England intervened.</em></p>
<p><strong>UK bond yields (ten year)</strong></p>
<figure class="align-center zoomable">
<a href="https://images.theconversation.com/files/528616/original/file-20230526-19-bzr2kc.png?ixlib=rb-1.1.0&q=45&auto=format&w=1000&fit=clip"><img alt="Chart showing UK 10 year gilts" src="https://images.theconversation.com/files/528616/original/file-20230526-19-bzr2kc.png?ixlib=rb-1.1.0&q=45&auto=format&w=754&fit=clip" srcset="https://images.theconversation.com/files/528616/original/file-20230526-19-bzr2kc.png?ixlib=rb-1.1.0&q=45&auto=format&w=600&h=348&fit=crop&dpr=1 600w, https://images.theconversation.com/files/528616/original/file-20230526-19-bzr2kc.png?ixlib=rb-1.1.0&q=30&auto=format&w=600&h=348&fit=crop&dpr=2 1200w, https://images.theconversation.com/files/528616/original/file-20230526-19-bzr2kc.png?ixlib=rb-1.1.0&q=15&auto=format&w=600&h=348&fit=crop&dpr=3 1800w, https://images.theconversation.com/files/528616/original/file-20230526-19-bzr2kc.png?ixlib=rb-1.1.0&q=45&auto=format&w=754&h=438&fit=crop&dpr=1 754w, https://images.theconversation.com/files/528616/original/file-20230526-19-bzr2kc.png?ixlib=rb-1.1.0&q=30&auto=format&w=754&h=438&fit=crop&dpr=2 1508w, https://images.theconversation.com/files/528616/original/file-20230526-19-bzr2kc.png?ixlib=rb-1.1.0&q=15&auto=format&w=754&h=438&fit=crop&dpr=3 2262w" sizes="(min-width: 1466px) 754px, (max-width: 599px) 100vw, (min-width: 600px) 600px, 237px"></a>
<figcaption>
<span class="caption">Bond prices are inversely related to yields, so when prices go down, yields go up.</span>
<span class="attribution"><a class="source" href="https://www.tradingview.com">Trading View</a></span>
</figcaption>
</figure>
<p><em>To find out why the is UK back at the brink and how dangerous it could be this time around, we spoke to David McMillan, a Professor of Finance at the University of Stirling.</em> </p>
<hr>
<h2>Why are bond yields close to crisis levels again?</h2>
<p>The simple answer is inflation. The <a href="https://www.bbc.co.uk/news/business-65682243">annual headline rate</a> came down to 8.7% in April compared to double figures in March – that was expected because April was the first month in 2022 to see a big inflation jump after the Ukraine invasion, so the year-on-year comparison is less severe now. But it was expected to be down to 8.2%, so it has been a disappointment. </p>
<p>This is mainly because of core inflation, which strips out things like food and energy that fluctuate a lot. Central banks like the Bank of England use core inflation as a more stable projection of where prices are going, and it <a href="https://edition.cnn.com/2023/05/24/economy/uk-inflation-fall-food-prices/index.html">rose to 6.8%</a> compared to 6.2% in March. The bank was probably not expecting that to happen. Service sector inflation is also sticking around the 7% mark. </p>
<p>A week ago the consensus was that the Bank of England maybe wouldn’t have done any more interest rate rises <a href="https://www.tradingview.com/symbols/ECONOMICS-GBINTR/">after 12</a> in the past 18 months, especially with the US Federal Reserve apparently now pausing, but now the expectation is a few more 0.25 point rises: maybe a total of 0.75 points or even 1 percentage point over the next year. Bond yields are rising to reflect that. </p>
<p>Also notice that it’s not just ten-year bonds: the yield on three-month bonds is 4.8%, meaning that you can get paid more for locking up your money for three months than ten years. Normally it’s the other way around. When the market inverts like that, it’s a sign that it is pricing in a recession. The <a href="https://www.bbc.co.uk/news/business-65669399">IMF has just</a> improved its forecast for the UK, saying it doesn’t expect a recession in 2023, but it’s on a knife edge to say the least. </p>
<p><strong>UK gilt yields (ten year v three month)</strong></p>
<figure class="align-center zoomable">
<a href="https://images.theconversation.com/files/528602/original/file-20230526-11640-qjiv18.png?ixlib=rb-1.1.0&q=45&auto=format&w=1000&fit=clip"><img alt="Graph charting UK gilt yields" src="https://images.theconversation.com/files/528602/original/file-20230526-11640-qjiv18.png?ixlib=rb-1.1.0&q=45&auto=format&w=754&fit=clip" srcset="https://images.theconversation.com/files/528602/original/file-20230526-11640-qjiv18.png?ixlib=rb-1.1.0&q=45&auto=format&w=600&h=344&fit=crop&dpr=1 600w, https://images.theconversation.com/files/528602/original/file-20230526-11640-qjiv18.png?ixlib=rb-1.1.0&q=30&auto=format&w=600&h=344&fit=crop&dpr=2 1200w, https://images.theconversation.com/files/528602/original/file-20230526-11640-qjiv18.png?ixlib=rb-1.1.0&q=15&auto=format&w=600&h=344&fit=crop&dpr=3 1800w, https://images.theconversation.com/files/528602/original/file-20230526-11640-qjiv18.png?ixlib=rb-1.1.0&q=45&auto=format&w=754&h=432&fit=crop&dpr=1 754w, https://images.theconversation.com/files/528602/original/file-20230526-11640-qjiv18.png?ixlib=rb-1.1.0&q=30&auto=format&w=754&h=432&fit=crop&dpr=2 1508w, https://images.theconversation.com/files/528602/original/file-20230526-11640-qjiv18.png?ixlib=rb-1.1.0&q=15&auto=format&w=754&h=432&fit=crop&dpr=3 2262w" sizes="(min-width: 1466px) 754px, (max-width: 599px) 100vw, (min-width: 600px) 600px, 237px"></a>
<figcaption>
<span class="caption">Blue = 10 year; Orange = 3 month.</span>
<span class="attribution"><a class="source" href="https://www.tradingview.com">Trading View</a></span>
</figcaption>
</figure>
<h2>Are Jeremy Hunt’s latest comments unhelpful?</h2>
<p>The <a href="https://www.theguardian.com/business/2023/may/26/jeremy-hunt-will-back-more-interest-rate-rises-even-if-it-pushes-uk-to-recession-bank-of-england">chancellor is saying</a> that a recession is a price worth paying for curbing inflation for political reasons. The government has set itself the target of halving inflation this year. </p>
<figure class="align-right zoomable">
<a href="https://images.theconversation.com/files/528619/original/file-20230526-25-6woo6x.jpeg?ixlib=rb-1.1.0&q=45&auto=format&w=1000&fit=clip"><img alt="Jeremy Hunt looking pensive" src="https://images.theconversation.com/files/528619/original/file-20230526-25-6woo6x.jpeg?ixlib=rb-1.1.0&q=45&auto=format&w=237&fit=clip" srcset="https://images.theconversation.com/files/528619/original/file-20230526-25-6woo6x.jpeg?ixlib=rb-1.1.0&q=45&auto=format&w=600&h=658&fit=crop&dpr=1 600w, https://images.theconversation.com/files/528619/original/file-20230526-25-6woo6x.jpeg?ixlib=rb-1.1.0&q=30&auto=format&w=600&h=658&fit=crop&dpr=2 1200w, https://images.theconversation.com/files/528619/original/file-20230526-25-6woo6x.jpeg?ixlib=rb-1.1.0&q=15&auto=format&w=600&h=658&fit=crop&dpr=3 1800w, https://images.theconversation.com/files/528619/original/file-20230526-25-6woo6x.jpeg?ixlib=rb-1.1.0&q=45&auto=format&w=754&h=826&fit=crop&dpr=1 754w, https://images.theconversation.com/files/528619/original/file-20230526-25-6woo6x.jpeg?ixlib=rb-1.1.0&q=30&auto=format&w=754&h=826&fit=crop&dpr=2 1508w, https://images.theconversation.com/files/528619/original/file-20230526-25-6woo6x.jpeg?ixlib=rb-1.1.0&q=15&auto=format&w=754&h=826&fit=crop&dpr=3 2262w" sizes="(min-width: 1466px) 754px, (max-width: 599px) 100vw, (min-width: 600px) 600px, 237px"></a>
<figcaption>
<span class="caption">Chancellor Jeremy Hunt.</span>
<span class="attribution"><a class="source" href="https://www.shutterstock.com/image-photo/berlin-germany-20180723-minister-foreign-affairs-1140820547">photocosmos1</a></span>
</figcaption>
</figure>
<p>It will get the credit if this happens. On the other hand, if inflation stays higher, Hunt is signalling to people that the Bank of England will be to blame, potentially creating a win-win for the government. But I don’t think the market is likely to be much influenced by what Hunt is saying. </p>
<h2>Is the US debt ceiling row making a difference?</h2>
<p>The debt ceiling is used for political horse-trading in the US. As always, there’s a <a href="https://www.bbc.co.uk/news/world-us-canada-65713732">general expectation</a> a deal will be done. What does affect the UK is what happens with the pound. If there is a danger that the US will increase interest rates, that will make the US dollar relatively more attractive and could drive down the value of the pound. </p>
<p>Since the UK is a major importer, a weaker pound could make inflation worse, so if the Fed did continue to raise US interest rates, there is a view that the Bank of England might do likewise to defend the pound. </p>
<h2>Will yields surpass the levels last autumn?</h2>
<p>I’m afraid they probably will rise, roughly in line with the Bank of England base rate. The only unknown is how aggressive the bank will be. </p>
<h2>Does that mean another panic for pension funds?</h2>
<p>Not necessarily. The problem for pension funds in 2022 was the speed at which yields moved after the mini-budget, around 1.2 points in about four days. Pension funds were using UK bonds as collateral on major market bets. When the value of that collateral fell so sharply, they faced margin calls from their lenders that meant they were in danger of losing their whole bets because they didn’t have the cash to make up the value of the collateral, which could have made them insolvent. </p>
<figure class="align-center zoomable">
<a href="https://images.theconversation.com/files/528618/original/file-20230526-19-d6dx8z.jpeg?ixlib=rb-1.1.0&q=45&auto=format&w=1000&fit=clip"><img alt="A very black looking piggy bank" src="https://images.theconversation.com/files/528618/original/file-20230526-19-d6dx8z.jpeg?ixlib=rb-1.1.0&q=45&auto=format&w=754&fit=clip" srcset="https://images.theconversation.com/files/528618/original/file-20230526-19-d6dx8z.jpeg?ixlib=rb-1.1.0&q=45&auto=format&w=600&h=400&fit=crop&dpr=1 600w, https://images.theconversation.com/files/528618/original/file-20230526-19-d6dx8z.jpeg?ixlib=rb-1.1.0&q=30&auto=format&w=600&h=400&fit=crop&dpr=2 1200w, https://images.theconversation.com/files/528618/original/file-20230526-19-d6dx8z.jpeg?ixlib=rb-1.1.0&q=15&auto=format&w=600&h=400&fit=crop&dpr=3 1800w, https://images.theconversation.com/files/528618/original/file-20230526-19-d6dx8z.jpeg?ixlib=rb-1.1.0&q=45&auto=format&w=754&h=503&fit=crop&dpr=1 754w, https://images.theconversation.com/files/528618/original/file-20230526-19-d6dx8z.jpeg?ixlib=rb-1.1.0&q=30&auto=format&w=754&h=503&fit=crop&dpr=2 1508w, https://images.theconversation.com/files/528618/original/file-20230526-19-d6dx8z.jpeg?ixlib=rb-1.1.0&q=15&auto=format&w=754&h=503&fit=crop&dpr=3 2262w" sizes="(min-width: 1466px) 754px, (max-width: 599px) 100vw, (min-width: 600px) 600px, 237px"></a>
<figcaption>
<span class="caption">UK pension funds had a near-death experience in autumn 2022.</span>
<span class="attribution"><a class="source" href="https://www.shutterstock.com/image-photo/black-piggy-bank-on-table-against-1172113240">New Africa</a></span>
</figcaption>
</figure>
<p>This time the move has been more like 0.5 points over the same period, so it’s not quite as dangerous. Meanwhile, the market has generally been positive for pension funds lately. The UK stock market has done well, climbing over 10% since the autumn debacle. Also, pension funds have been benefiting from higher interest rates because it means they’re putting more of their money into higher-yielding bonds as previous investments reach maturity. </p>
<p>Finally, <a href="https://www.ft.com/content/b06f5a77-f8de-4d02-a307-5ec07a7494da">funds have reduced</a> their exposure to <a href="https://theconversation.com/bank-of-england-bonds-rescue-has-two-ugly-implications-more-inflation-and-an-even-weaker-pound-191653">liability-driven investment strategies (LDIs)</a>, which were the parts of their investment portfolios that blew up in 2022. </p>
<h2>Are there increased risks of contagion from the US banking crisis?</h2>
<p>Higher interest rates have in one sense been good news for banks because they’ve been able to make a greater return on their investments while getting away with not paying higher saving rates to customers. In the US, this has prompted lots of customers to withdraw their deposits and put them into other things like money market funds, which has seen some banks running out of cash, but we haven’t seen that so much in the UK. </p>
<p>Also, US mid-sized banks have had weakened balance sheets because the regulations were <a href="https://theconversation.com/the-european-central-bank-seems-to-have-got-away-with-raising-interest-rates-in-the-middle-of-a-banking-crisis-heres-why-202052">relaxed under President Trump</a>, which has made them more vulnerable to bank runs. By comparison, the UK has more stringent regulation. </p>
<p>It’s certainly the case that UK banks’ balance sheets will be weakened by their bond holdings losing value. Whether it leads to contagion possibly depends on how aggressively the Bank of England responds to inflation. If it just does another two or three 0.25 point rises, the UK banks may come through without serious problems.</p><img src="https://counter.theconversation.com/content/206533/count.gif" alt="The Conversation" width="1" height="1" />
<p class="fine-print"><em><span>David McMillan does not work for, consult, own shares in or receive funding from any company or organisation that would benefit from this article, and has disclosed no relevant affiliations beyond their academic appointment.</span></em></p>UK bonds are again close to the levels that caused a pensions crisis in autumn 2022.David McMillan, Professor in Finance, University of StirlingLicensed as Creative Commons – attribution, no derivatives.tag:theconversation.com,2011:article/2045212023-05-24T13:40:38Z2023-05-24T13:40:38ZWhy profits, not pay, have caused the cost of living crisis<figure><img src="https://images.theconversation.com/files/527752/original/file-20230523-29-w662k2.jpg?ixlib=rb-1.1.0&rect=178%2C95%2C7618%2C5130&q=45&auto=format&w=496&fit=clip" /><figcaption><span class="caption">Budgeting for a rising cost of living.</span> <span class="attribution"><a class="source" href="https://www.shutterstock.com/image-photo/mature-middleaged-couple-family-wife-husband-1994498774">Inside Creative House/Shutterstock</a></span></figcaption></figure><p>The Bank of England accompanied its most recent UK interest rate hike – <a href="https://www.bankofengland.co.uk/monetary-policy-summary-and-minutes/2023/may-2023">the 12th in a row</a> – with a warning that UK price inflation is likely to be <a href="https://uk.finance.yahoo.com/news/bank-england-lifts-interest-rates-110713037.html">higher for longer than expected</a> due to soaring food costs. The bank has been hiking rates since December 2021 to try to stop a sharp rise in the cost of living. And while the rate of inflation <a href="https://www.theguardian.com/business/2023/may/24/uk-inflation-falls-cost-of-living-crisis">dropped significantly in April</a>, at 8.7% it remains well above the UK’s 2% target.</p>
<p>Many reasons have been given for recent price inflation: central banks have <a href="https://www.investorschronicle.co.uk/news/2023/05/10/did-central-banks-cause-today-s-inflation-spiral/">“printed” too much money</a>, wars in other countries have <a href="https://www.theguardian.com/business/2023/feb/21/energy-crisis-ukraine-war-uk-cost-gas">pushed up energy prices</a>. The <a href="https://news.sky.com/story/rishi-sunak-says-public-sector-pay-rises-will-fuel-inflation-economists-say-they-wont-12779761#:%7E:text=Rishi%20Sunak%20has%20said%20he,prices%20in%20a%20perpetual%20loop.">current government</a> and the <a href="https://www.theguardian.com/business/2022/feb/04/bank-of-england-boss-calls-for-wage-restraint-to-help-control-inflation">governor of the Bank of England</a> believe that wage increases cause inflation. </p>
<p>But <a href="https://www.versobooks.com/en-gb/products/3146-the-cost-of-living-crisis">my research</a>, with James Meadway of the Progressive Economy Forum and Doug Nicholls of the General Federation of Trade Unions, looks at how UK price rises are more likely to have been caused by high profits, falling wages and weak production over decades.</p>
<h2>Pay negotiations</h2>
<p>In the mid-to-late 1970s, trade unions were able to negotiate wages through nationally organised systems of collective bargaining. This is where groups of employees, typically represented by a union, discuss wages and conditions with their employer. The gap between the wealth of business and labour at that time was significantly less, and Britain was a <a href="https://researchbriefings.files.parliament.uk/documents/CBP-7484/CBP-7484.pdf">more equal society in terms of income</a>.</p>
<p>A concerted assault on collective bargaining since then has greatly weakened workers’ ability to defend the value of their wages, at least by keeping pace with inflation. At the same time, income inequality has soared and is <a href="https://researchbriefings.files.parliament.uk/documents/CBP-7484/CBP-7484.pdf">expected to reach a high by 2027</a>. <a href="https://www.bruegel.org/analysis/collective-bargaining-associated-lower-income-inequality">Research shows evidence</a> of an inverse relationship between the number of workers organised in trade unions and their ability to use collective bargaining, versus the wealth concentrated in the hands of the richest elite.</p>
<p>As workers today start to realise this, it might explain <a href="https://www.dailymail.co.uk/news/article-12115963/London-Underground-workers-vote-overwhelmingly-favour-strikes-RMT-union-announces.html">recent support for strike action</a> as unions try to maintain the value of wages in the face of persistent inflation.</p>
<hr>
<p>
<em>
<strong>
Read more:
<a href="https://theconversation.com/recent-pay-rises-suggest-that-collective-bargaining-may-be-on-the-way-back-199436">Recent pay rises suggest that collective bargaining may be on the way back</a>
</strong>
</em>
</p>
<hr>
<p>But it’s also important to be aware of the deeper, historic and strategic factors that have led to <a href="https://www.reuters.com/markets/currencies/dollar-hovers-near-2-month-high-debt-ceiling-angst-saps-risk-appetite-2023-05-24/">relatively high levels of inflation in Britain</a>. Addressing these issues will help get the UK out of the current cost of living crisis.</p>
<h2>A manufacturing powerhouse</h2>
<p>The first <a href="https://www.britannica.com/event/Industrial-Revolution">industrial revolution</a>, starting in the 18th century, made the UK a leading producer of manufactured products – the “<a href="https://www.encyclopedia.com/humanities/dictionaries-thesauruses-pictures-and-press-releases/workshop-world#:%7E:text=Workshop%20of%20the%20World%20informal,British%20manufacturing%20and%20industrial%20capacity.">workshop of the world</a>”. And it remained a major manufacturing power for more than a century, creating everything from cruise liners to <a href="https://www.computerweekly.com/feature/CW50-The-heyday-of-British-computing-How-the-Brits-ruled-IT">some of the first computer programs</a>.</p>
<p>But in the 1980s, Thatercherism undermined productive industry and skills development by shrinking entire sectors of the economy, such as <a href="https://www.theguardian.com/business/2016/mar/30/steel-in-the-uk-a-timeline-of-decline">steel-making</a>, <a href="https://www.researchgate.net/publication/308940455_Industrial_policy_and_the_British_automotive_industry_under_Margaret_Thatcher">car-making</a>, and <a href="https://www.history.co.uk/article/how-thatcher-broke-the-miners-strike-but-at-what-cost">coal production</a>. At the same time, the government <a href="https://www.investopedia.com/terms/b/bigbang.asp">loosened financial regulation</a> and removed controls on the flow of money out of the country, boosting the rule of finance.</p>
<p>This skewed the British economy away from its manufacturing heartlands, such as the Midlands, while inflating the political and economic power of banks and financial firms. Profits became less dependent on production.</p>
<p>Since 1960, British manufacturing has been in decline, both <a href="https://res.org.uk/mediabriefing/uk-industrial-performance-since-1960-does-the-failure-of-manufacturing-matter/">in terms of employment and output</a>, and in comparison to other similar countries. Low business investment over the decades has held the UK back versus the likes of the US, France and Germany, <a href="https://www.reuters.com/business/weak-investment-innovation-management-hamper-uk-productivity-2021-11-15/">leading to low productivity</a>.</p>
<p>This historic shock to the productive system of the UK meant that, when demand for goods grew post-COVID, there was little domestic capacity to produce them – so the country had to <a href="https://commonslibrary.parliament.uk/research-briefings/cbp-7851/">rely on imports to meet demand</a>. The costs of the most basic goods and services that we need – <a href="https://www.ons.gov.uk/economy/inflationandpriceindices/articles/costofliving/latestinsights">food, energy and housing</a> – have since soared. These essentials, which should be a relatively low proportion of our spending, have become unaffordable for millions of people. </p>
<p>Of course, price controls could help to reduce this inflation. But the underlying weaknesses that facilitate inflation in the long run should also be addressed. This will require a new UK industrial policy, together with plans for skills development for the workforce.</p>
<p>Curbs on the flow of business and money out of the country by banks, investment funds and large enterprises will help strengthen domestic investment. New approaches to public financing via organisations such as the central bank would also reduce the reliance on private banks. Rather than its remit being linked to profit and controlling inflation, for example, the Bank of England should focus on supporting investment by directing funds toward particular sectors, especially manufacturing.</p>
<figure class="align-center ">
<img alt="Bright blue sky behind Bank of England building with union flag flying." src="https://images.theconversation.com/files/527762/original/file-20230523-19-eaz6vt.jpg?ixlib=rb-1.1.0&q=45&auto=format&w=754&fit=clip" srcset="https://images.theconversation.com/files/527762/original/file-20230523-19-eaz6vt.jpg?ixlib=rb-1.1.0&q=45&auto=format&w=600&h=400&fit=crop&dpr=1 600w, https://images.theconversation.com/files/527762/original/file-20230523-19-eaz6vt.jpg?ixlib=rb-1.1.0&q=30&auto=format&w=600&h=400&fit=crop&dpr=2 1200w, https://images.theconversation.com/files/527762/original/file-20230523-19-eaz6vt.jpg?ixlib=rb-1.1.0&q=15&auto=format&w=600&h=400&fit=crop&dpr=3 1800w, https://images.theconversation.com/files/527762/original/file-20230523-19-eaz6vt.jpg?ixlib=rb-1.1.0&q=45&auto=format&w=754&h=503&fit=crop&dpr=1 754w, https://images.theconversation.com/files/527762/original/file-20230523-19-eaz6vt.jpg?ixlib=rb-1.1.0&q=30&auto=format&w=754&h=503&fit=crop&dpr=2 1508w, https://images.theconversation.com/files/527762/original/file-20230523-19-eaz6vt.jpg?ixlib=rb-1.1.0&q=15&auto=format&w=754&h=503&fit=crop&dpr=3 2262w" sizes="(min-width: 1466px) 754px, (max-width: 599px) 100vw, (min-width: 600px) 600px, 237px">
<figcaption>
<span class="caption">The Bank of England.</span>
<span class="attribution"><a class="source" href="https://www.shutterstock.com/image-photo/bank-england-your-travel-concept-704695771">aslysun/Shutterstock</a></span>
</figcaption>
</figure>
<p>Britain’s extreme unleashing of market forces in the 1980s involved unprecedented privatisation and selling of public assets, wholesale deindustrialisation, and deregulation of the finance sector. During the years that followed, it included the systematic introduction of anti-union legislation and the dismantling of collective bargaining, leading to continuous downward pressure on wages as workers have less power to stand up to employers.</p>
<hr>
<p>
<em>
<strong>
Read more:
<a href="https://theconversation.com/uk-strikes-how-margaret-thatcher-and-other-leaders-cut-trade-union-powers-over-centuries-186270">UK strikes: how Margaret Thatcher and other leaders cut trade union powers over centuries</a>
</strong>
</em>
</p>
<hr>
<p>Corporate economic and political power was strengthened and, as a result, big businesses have been able to help themselves to extraordinary profits – often with <a href="https://pure.qub.ac.uk/en/publications/shortcomings-of-the-energy-oil-and-gas-profits-levy">additional government help</a>, including tax breaks and subsidies.</p>
<p>Unions have recently accused <a href="https://www.unitetheunion.org/media/5442/profiteering-across-the-economy-march-2023.pdf">big business of “profiteering”</a> amid this cost of living crisis, and some supermarkets have <a href="https://www.bbc.co.uk/news/business-65531197">started to cut prices</a> in response to this criticism.</p>
<p>But no amount of windfall taxes or <a href="https://www.gov.uk/government/publications/energy-bills-support/energy-bills-support-factsheet-8-september-2022">household subsidies</a> will stop the current profit binge at the expense of wages. Major structural change is needed. If this is not done, the current toxic mix of weak investment, low productivity and high inflation is likely to be disastrous for our country.</p><img src="https://counter.theconversation.com/content/204521/count.gif" alt="The Conversation" width="1" height="1" />
<p class="fine-print"><em><span>Costas Lapavitsas does not work for, consult, own shares in or receive funding from any company or organisation that would benefit from this article, and has disclosed no relevant affiliations beyond their academic appointment.</span></em></p>My research shows that UK price rises are likely to have been caused by high profits, falling wages and weak production over decadesCostas Lapavitsas, Professor of Economics, SOAS, University of LondonLicensed as Creative Commons – attribution, no derivatives.tag:theconversation.com,2011:article/2053362023-05-17T10:46:24Z2023-05-17T10:46:24ZMortgage lenders are relaxing their rules – here’s why that could be risky for borrowers<figure><img src="https://images.theconversation.com/files/526553/original/file-20230516-17-melcmo.jpg?ixlib=rb-1.1.0&rect=137%2C47%2C3856%2C2443&q=45&auto=format&w=496&fit=clip" /><figcaption><span class="caption">Budgeting to buy a home.</span> <span class="attribution"><a class="source" href="https://www.shutterstock.com/image-photo/buying-selling-houses-real-estate-prices-1032268546">Tero Vesalainen/Shutterstock</a></span></figcaption></figure><p>The Bank of England increased its base rate yet again in May 2023 to 4.5%, pushing borrowing costs to the <a href="https://theconversation.com/bank-of-england-interest-rate-rise-why-this-could-be-the-last-increase-for-a-while-205337">highest level in almost 15 years</a>. More than <a href="https://www.bankofengland.co.uk/financial-stability-report/2022/december-2022">6 million UK households</a> will now see their mortgage payments increase by the end of 2025, with more than <a href="https://www.bankofengland.co.uk/financial-stability-report/2022/december-2022">4 million</a> experiencing this in 2023.</p>
<p>For an average household this would mean an increase from <a href="https://www.bankofengland.co.uk/financial-stability-report/2022/december-2022">£750 to £1,000 in monthly payments</a> – or around 17% of average pre-tax income compared to 12% in June 2022. As the pressure of increasing interest costs, as well as rising house prices, weighs on households, mortgage lenders are developing and offering borrowers different kinds of products in response. </p>
<p>UK lender Skipton Building Society <a href="https://www.skipton.co.uk/press-office/press-release-article?BlogID=%7B13A47958-66DB-4D1A-B686-F7BFCF3FD742%7D">recently launched a 100% or no-deposit mortgage</a> as “a lifeline to tenants across the country, to help them break out of their trapped rental cycles and onto the property ladder for the first time”. Alternatively, <a href="https://www.ftadviser.com/mortgages/2019/06/26/most-mortgages-now-have-40-year-terms/?utm_campaign=FTAdviser+news&utm_source=emailCampaign&utm_medium=email&utm_content=">home loans that last as long as 40 years</a> – so-called <a href="https://www.thisismoney.co.uk/money/mortgageshome/article-12079901/63-000-thats-extra-cost-150-000-marathon-mortgage.html">marathon mortgages</a> – are on the rise. They can make it easier for some people to get on the property ladder by stretching out payments over a longer period.</p>
<p>But mortgage lending criteria were <a href="https://www.tandfonline.com/doi/full/10.1080/14616718.2011.548585?scroll=top&needAccess=true&role=tab&aria-labelledby=full-article">tightened for good reason after the 2008 global financial crisis</a>. And while these recent relaxations may be designed to help struggling would-be borrowers trapped in rising interest rate, rent and house price hell, hopeful homeowners should be very cautious about the risks involved.</p>
<h2>Long-term loans</h2>
<p>Prior to 2007, mortgage terms were rarely longer than 25 years. Only about 21% of first-time borrowers and 8% of remortgages opted for such a long term in December 2007. While <a href="https://www.zoopla.co.uk/discover/property-news/uk-lender-offers-40-year-fixed-rate-mortgage/">one lender</a> started offering a 40-year fixed rate product at the end of 2021, marathon mortgages are long-term loans but don’t typically offer a fixed rate for the length of the loan. By 2022 more than 55% of first-time borrowers and 34% of remortgagers had <a href="https://www.ukfinance.org.uk/system/files/2023-03/Household%20Finance%20Review%202022%20Q4.pdf">home loans with terms of more than 30 years</a>.</p>
<p><strong>Mortgage terms are getting longer</strong></p>
<p>This recent resurgence is most likely due to the affordability benefits of marathon mortgages. <a href="https://theconversation.com/five-ways-to-reduce-your-mortgage-repayments-in-2023-and-why-rates-have-risen-so-high-196327">Extending the term of a loan allows borrowers</a> to stretch out the repayment costs of a mortgage over time. It also allows people to purchase a more expensive home – an important benefit in today’s market where average house prices have rocketed from £190,000 in 2009 to just shy of £300,000 in 2023.</p>
<p><strong>House prices have been rising</strong></p>
<figure class="align-center zoomable">
<a href="https://images.theconversation.com/files/526300/original/file-20230515-25-mdvsxb.png?ixlib=rb-1.1.0&q=45&auto=format&w=1000&fit=clip"><img alt="Line chart showing rising UK average house prices since 2005." src="https://images.theconversation.com/files/526300/original/file-20230515-25-mdvsxb.png?ixlib=rb-1.1.0&q=45&auto=format&w=754&fit=clip" srcset="https://images.theconversation.com/files/526300/original/file-20230515-25-mdvsxb.png?ixlib=rb-1.1.0&q=45&auto=format&w=600&h=339&fit=crop&dpr=1 600w, https://images.theconversation.com/files/526300/original/file-20230515-25-mdvsxb.png?ixlib=rb-1.1.0&q=30&auto=format&w=600&h=339&fit=crop&dpr=2 1200w, https://images.theconversation.com/files/526300/original/file-20230515-25-mdvsxb.png?ixlib=rb-1.1.0&q=15&auto=format&w=600&h=339&fit=crop&dpr=3 1800w, https://images.theconversation.com/files/526300/original/file-20230515-25-mdvsxb.png?ixlib=rb-1.1.0&q=45&auto=format&w=754&h=427&fit=crop&dpr=1 754w, https://images.theconversation.com/files/526300/original/file-20230515-25-mdvsxb.png?ixlib=rb-1.1.0&q=30&auto=format&w=754&h=427&fit=crop&dpr=2 1508w, https://images.theconversation.com/files/526300/original/file-20230515-25-mdvsxb.png?ixlib=rb-1.1.0&q=15&auto=format&w=754&h=427&fit=crop&dpr=3 2262w" sizes="(min-width: 1466px) 754px, (max-width: 599px) 100vw, (min-width: 600px) 600px, 237px"></a>
<figcaption>
<span class="caption"></span>
<span class="attribution"><a class="source" href="https://www.ons.gov.uk/economy/inflationandpriceindices/bulletins/housepriceindex/previousReleases">Office for National Statistics UK House Price Index</a></span>
</figcaption>
</figure>
<p>Long-term mortgages also help borrowers qualify for mortgages under the <a href="https://www.fca.org.uk/news/press-releases/new-mortgage-rules-come-force">stricter affordability rules</a> introduced by the UK’s financial regulator in 2014. These rules require lenders to ensure that borrowers have sufficient monthly income to cover living expenses and other debts after their mortgage payments. </p>
<p>Spreading the cost to around 40 years allows marathon mortgage holders to reduce monthly costs, passing affordability assessments. Marathon mortgages do not seem to be a current concern for the regulator.</p>
<p>Of course, a marathon mortgage borrower could shorten their term over the years as they remortgage to avoid the lender’s standard variable rate. Also, if the base rate decreases over time, interest payments will fall and the overall mortgage will become more affordable. And, of course, any future increase in income allows a borrower to overpay during the term of the loan.</p>
<p>On the the other hand, long-term borrowing means significantly higher interest payments. For example, <a href="https://www.moneysavingexpert.com/mortgages/mortgage-rate-calculator/">a household borrowing £250,000 at a rate of 5% for 25 years</a> would pay a total of £188,600 in interest over the lifetime of the mortgage (assuming, for simplicity, that the interest rate does not change over the life of the mortgage). But borrowing for 40 years would result in total interest payments of £328,930 – a staggering £140,330 difference.</p>
<p>Marathon mortgages may also mean borrowers must make repayments <a href="https://www.ukfinance.org.uk/system/files/2023-03/Household%20Finance%20Review%202022%20Q4.pdf">well into their 70s</a> considering the <a href="https://www.money.co.uk/mortgages/first-time-buyer-mortgages/statistics">average age for first-time buyers outside London is now around 33</a>. For some this may mean continuing to pay a mortgage into retirement. This should be a key consideration when considering long-term borrowing. It would certainly impact financial security after retirement so careful planning and independent financial advice is crucial.</p>
<figure class="align-center ">
<img alt="Hands cupped underneath chart showing rising house values." src="https://images.theconversation.com/files/526552/original/file-20230516-24-pw785y.jpg?ixlib=rb-1.1.0&q=45&auto=format&w=754&fit=clip" srcset="https://images.theconversation.com/files/526552/original/file-20230516-24-pw785y.jpg?ixlib=rb-1.1.0&q=45&auto=format&w=600&h=400&fit=crop&dpr=1 600w, https://images.theconversation.com/files/526552/original/file-20230516-24-pw785y.jpg?ixlib=rb-1.1.0&q=30&auto=format&w=600&h=400&fit=crop&dpr=2 1200w, https://images.theconversation.com/files/526552/original/file-20230516-24-pw785y.jpg?ixlib=rb-1.1.0&q=15&auto=format&w=600&h=400&fit=crop&dpr=3 1800w, https://images.theconversation.com/files/526552/original/file-20230516-24-pw785y.jpg?ixlib=rb-1.1.0&q=45&auto=format&w=754&h=503&fit=crop&dpr=1 754w, https://images.theconversation.com/files/526552/original/file-20230516-24-pw785y.jpg?ixlib=rb-1.1.0&q=30&auto=format&w=754&h=503&fit=crop&dpr=2 1508w, https://images.theconversation.com/files/526552/original/file-20230516-24-pw785y.jpg?ixlib=rb-1.1.0&q=15&auto=format&w=754&h=503&fit=crop&dpr=3 2262w" sizes="(min-width: 1466px) 754px, (max-width: 599px) 100vw, (min-width: 600px) 600px, 237px">
<figcaption>
<span class="caption"></span>
<span class="attribution"><a class="source" href="https://www.shutterstock.com/image-photo/rising-house-sales-concept-742144642">Sasun Bughdaryan/Shutterstock</a></span>
</figcaption>
</figure>
<h2>No-deposit mortgages</h2>
<p>Rising rents, coupled with <a href="https://www.ft.com/content/0ebcf348-a664-442c-9311-5443e2d80f53">soaring prices of other essential expenses</a> such as food and energy bills, have left many first-time buyers struggling to save for a deposit. No-deposit products help first-time buyers break this cycle by swapping rental costs with mortgage payments, allowing them to eventually own their home. </p>
<p>Skipton Building Society’s recent launch of a <a href="https://www.skipton.co.uk/mortgages/track-record-mortgage">“100% mortgage”, which means borrowers don’t need a deposit</a>, aims to help first-time buyers of homes of up to £600,000 get onto the property ladder. </p>
<p>Such products were commonly available before the 2008 financial crisis. But the sharp fall in house prices since – mainly the 20% drop between 2007 and 2009 – <a href="https://www.ft.com/content/f067f31e-56c8-11de-9a1c-00144feabdc0">is reported to have left around a million households stuck in negative equity</a>. This is when your home is worth less than the mortgage you owe on it, leaving you unable to sell your properties.</p>
<p>The danger now is that the average house price today is much higher than the pre-financial crisis period (£300,000 versus £190,000). So, if such price drop were to happen in the near future, the impact would be even more devastating for no-deposit mortgagers. Although a crash does not seem to be on the cards, <a href="https://www.halifax.co.uk/assets/pdf/april-2023-house-price-index.pdf">downward pressure on house prices is expected</a>. </p>
<hr>
<p>
<em>
<strong>
Read more:
<a href="https://theconversation.com/uk-house-prices-history-says-the-market-is-in-for-a-long-slowdown-not-a-crash-186072">UK house prices: history says the market is in for a long slowdown not a crash</a>
</strong>
</em>
</p>
<hr>
<p>As we experienced in the aftermath of the 2008 financial crisis, relaxed lending criteria combined with borrowing beyond means can have dire consequences. It’s important for borrowers to be aware of these risks and to be very cautious when thinking about borrowing for the long term, particularly without a deposit.</p><img src="https://counter.theconversation.com/content/205336/count.gif" alt="The Conversation" width="1" height="1" />
<p class="fine-print"><em><span>Alper Kara does not work for, consult, own shares in or receive funding from any company or organisation that would benefit from this article, and has disclosed no relevant affiliations beyond their academic appointment.</span></em></p>New mortgage products designed to help struggling first-time buyers hark back to the pre-2008 market and so should come with a warning.Alper Kara, Professor and Head of Department - Accounting, Finance and Economics, University of HuddersfieldLicensed as Creative Commons – attribution, no derivatives.tag:theconversation.com,2011:article/2056702023-05-15T15:43:24Z2023-05-15T15:43:24ZUK economy: why the Bank of England is now more upbeat than the IMF<p>The Bank of England has changed its mind about the prospects for the UK economy. Having been predicting a recession in 2023 as <a href="https://www.bankofengland.co.uk/monetary-policy-report/2023/february-2023">recently as February</a>, its latest <a href="https://www.bankofengland.co.uk/monetary-policy-report/2023/may-2023">May report</a> is expecting a soft landing from the bout of high inflation and a year of interest rate hikes. </p>
<p>One reason is that global demand for goods and services is expected to be higher. The central bank now expects weak GDP growth of 0.25% in 2023 compared to a predicted 0.5% contraction in the previous report, and thinks growth will be 0.75% in both 2024 and 2025. It said:</p>
<blockquote>
<p>Growth over much of the forecast period will be materially stronger than in the February report. This reflects stronger global growth, lower energy prices, the fiscal support in the spring budget, and the possibility of lower precautionary saving by households than previously assumed in turn related to a lower risk of job loss …</p>
</blockquote>
<p>This is quite a different picture to the one depicted by the IMF (International Monetary Fund) <a href="https://www.imf.org/en/Publications/WEO/Issues/2023/04/11/world-economic-outlook-april-2023">in April</a>. The IMF said UK GDP would fall 0.3% in 2023 but then rebound to 1% in 2024. </p>
<p>Its reasons for being more pessimistic are that the UK was <a href="https://www.reuters.com/world/uk/uk-economy-set-smaller-hit-2023-than-previously-feared-imf-2023-04-11/#:%7E:text=British%20gross%20domestic%20product%20will,the%20Fund%20predicted%20in%20January">heavily exposed</a> to the recent global shock in energy prices, its banks are vulnerable to the <a href="https://www.imf.org/en/Blogs/Articles/2023/04/04/nonbank-financial-sector-vulnerabilities-surface-as-financial-conditions-tighten">crisis engulfing the US</a>, interest rates are high and the public finances are somewhat precarious. </p>
<p>Even the <a href="https://theconversation.com/spring-budget-2023-experts-react-to-uk-governments-plan-to-get-the-economy-moving-201893">recent efforts</a> by Chancellor Jeremy Hunt to <a href="https://www.bbc.co.uk/news/business-64789405">revitalise the economy</a>, such as encouraging business investment and simplifying international trade, were not met with enthusiasm by <a href="https://www.ft.com/content/530f07a4-992d-462c-9b0a-87267685f36c">IMF economists</a>. The chancellor was left vowing that the UK economy will “<a href="https://news.sky.com/story/chancellor-jeremy-hunt-insists-he-will-prove-imf-forecast-wrong-12857155">prove the IMF wrong</a>”.</p>
<p>The difference between these two sets of forecasts is striking. The question then becomes, is the Bank of England too optimistic about the future UK economic outlook or is the IMF painting too gloomy a picture?</p>
<h2>Understanding the difference</h2>
<p>The IMF has been one of the most pessimistic forecasters about the UK economy of late. As the <a href="https://www.gov.uk/government/speeches/spring-budget-2023-speech">chancellor said</a> during his spring budget, “our IMF growth forecasts have been upgraded by more than any other G7 country”. Indeed, even the IMF’s April forecast is a revision upwards from the 0.6% contraction for 2023 that it was fearing <a href="https://www.imf.org/en/Publications/WEO/Issues/2023/01/31/world-economic-outlook-update-january-2023">back in January</a>, bringing it closer in line with the 0.2% contraction that the government’s <a href="https://obr.uk/docs/dlm_uploads/OBR-EFO-March-2023_Web_Accessible.pdf">Office for Budget Responsibility (OBR) predicted</a> at the time of the budget. </p>
<figure class="align-center zoomable">
<a href="https://images.theconversation.com/files/526247/original/file-20230515-20429-ummfq5.jpeg?ixlib=rb-1.1.0&q=45&auto=format&w=1000&fit=clip"><img alt="Jeremy Hunt standing outside 10 Downing Street" src="https://images.theconversation.com/files/526247/original/file-20230515-20429-ummfq5.jpeg?ixlib=rb-1.1.0&q=45&auto=format&w=754&fit=clip" srcset="https://images.theconversation.com/files/526247/original/file-20230515-20429-ummfq5.jpeg?ixlib=rb-1.1.0&q=45&auto=format&w=600&h=480&fit=crop&dpr=1 600w, https://images.theconversation.com/files/526247/original/file-20230515-20429-ummfq5.jpeg?ixlib=rb-1.1.0&q=30&auto=format&w=600&h=480&fit=crop&dpr=2 1200w, https://images.theconversation.com/files/526247/original/file-20230515-20429-ummfq5.jpeg?ixlib=rb-1.1.0&q=15&auto=format&w=600&h=480&fit=crop&dpr=3 1800w, https://images.theconversation.com/files/526247/original/file-20230515-20429-ummfq5.jpeg?ixlib=rb-1.1.0&q=45&auto=format&w=754&h=603&fit=crop&dpr=1 754w, https://images.theconversation.com/files/526247/original/file-20230515-20429-ummfq5.jpeg?ixlib=rb-1.1.0&q=30&auto=format&w=754&h=603&fit=crop&dpr=2 1508w, https://images.theconversation.com/files/526247/original/file-20230515-20429-ummfq5.jpeg?ixlib=rb-1.1.0&q=15&auto=format&w=754&h=603&fit=crop&dpr=3 2262w" sizes="(min-width: 1466px) 754px, (max-width: 599px) 100vw, (min-width: 600px) 600px, 237px"></a>
<figcaption>
<span class="caption">Chancellor Jeremy Hunt is determined to prove the IMF wrong.</span>
<span class="attribution"><a class="source" href="https://www.alamy.com/chancellor-of-the-exchequer-jeremy-hunt-leaves-11-downing-street-to-deliver-his-spring-budget-to-parliament-image542606529.html?imageid=9F8CE291-9998-4CED-BFE5-73286164C445&p=794922&pn=1&searchId=9350fb8e8188e73bd9469defcb152ddb&searchtype=0">Thomas Crych/Alamy</a></span>
</figcaption>
</figure>
<p>This apparent lag in the IMF forecasts may be linked to how often it updates its economic models. The Bank of England and OBR do this routinely as new data becomes available, ensuring that the projections adapt more quickly to changes in the underlying economic signals. In forecasting, data revisions play an important role in updates. For instance, the OBR updated its assessment of the public finances <a href="https://obr.uk/docs/dlm_uploads/March-2023-PSF-commentary-1.pdf">in late April</a> on the back of new data about the spending deficit. </p>
<p>In contrast, global institutions like the IMF and OECD (Organisation for Economic Co-Operation and Development) conduct their reassessments much less frequently (usually twice a year). This means that institutional forecasters have less chance to update their projections and that when they do so, they’re usually a few months behind the curve. </p>
<h2>What next</h2>
<p>Be that as it may, is the Bank of England is likely to be right? On the prospect of increased household spending, the bank is seeing consumers dipping into their COVID savings because they’re feeling more secure in their jobs at a time when the <a href="https://www.ons.gov.uk/employmentandlabourmarket/peoplenotinwork/redundancies">redundancy rate</a> has dipped sharply from pandemic levels. </p>
<p><strong>Household savings ratio 2000-22</strong></p>
<figure class="align-center zoomable">
<a href="https://images.theconversation.com/files/526232/original/file-20230515-19465-ummfq5.png?ixlib=rb-1.1.0&q=45&auto=format&w=1000&fit=clip"><img alt="Graph showing household savings ratio over time" src="https://images.theconversation.com/files/526232/original/file-20230515-19465-ummfq5.png?ixlib=rb-1.1.0&q=45&auto=format&w=754&fit=clip" srcset="https://images.theconversation.com/files/526232/original/file-20230515-19465-ummfq5.png?ixlib=rb-1.1.0&q=45&auto=format&w=600&h=307&fit=crop&dpr=1 600w, https://images.theconversation.com/files/526232/original/file-20230515-19465-ummfq5.png?ixlib=rb-1.1.0&q=30&auto=format&w=600&h=307&fit=crop&dpr=2 1200w, https://images.theconversation.com/files/526232/original/file-20230515-19465-ummfq5.png?ixlib=rb-1.1.0&q=15&auto=format&w=600&h=307&fit=crop&dpr=3 1800w, https://images.theconversation.com/files/526232/original/file-20230515-19465-ummfq5.png?ixlib=rb-1.1.0&q=45&auto=format&w=754&h=386&fit=crop&dpr=1 754w, https://images.theconversation.com/files/526232/original/file-20230515-19465-ummfq5.png?ixlib=rb-1.1.0&q=30&auto=format&w=754&h=386&fit=crop&dpr=2 1508w, https://images.theconversation.com/files/526232/original/file-20230515-19465-ummfq5.png?ixlib=rb-1.1.0&q=15&auto=format&w=754&h=386&fit=crop&dpr=3 2262w" sizes="(min-width: 1466px) 754px, (max-width: 599px) 100vw, (min-width: 600px) 600px, 237px"></a>
<figcaption>
<span class="caption">The data is seasonally adjusted.</span>
<span class="attribution"><span class="source">Office for National Statistics</span></span>
</figcaption>
</figure>
<p>I would certainly agree that this will give a decent boost to the UK economy if the trend continues. The risk is that unemployment may start rising again and consumer confidence will tank. This would probably cause people to hold on to their savings and essentially shut down this growth channel. </p>
<p>As for interest rates, the latest Bank of England report sees the base rate peaking at 4.75% in the final quarter of 2023 and then coming down to around 3.5% by 2026. With the base rate already now at 4.5%, this means the bank is signalling that the hiking cycle is almost over. </p>
<p>We know that households and firms base their spending decisions not only on current interest rates but also on this “forward guidance”. So an expectation of lower rates might indeed increase spending and investment, as well as having a positive effect on the housing market, which currently <a href="https://www.ft.com/content/dc19e220-1451-40e1-8c0f-f9e4040eea86">seems to be stabilising</a> after a few months in decline. However, the latest bank forecast is also that interest rates will come down more slowly than before, so this might actually weaken spending and investment. </p>
<p><strong>Interest rate projections (UK, US, eurozone)</strong></p>
<figure class="align-center zoomable">
<a href="https://images.theconversation.com/files/526239/original/file-20230515-23646-uevzio.png?ixlib=rb-1.1.0&q=45&auto=format&w=1000&fit=clip"><img alt="Graph showing likely interest rate movement in UK, eurozone and US" src="https://images.theconversation.com/files/526239/original/file-20230515-23646-uevzio.png?ixlib=rb-1.1.0&q=45&auto=format&w=754&fit=clip" srcset="https://images.theconversation.com/files/526239/original/file-20230515-23646-uevzio.png?ixlib=rb-1.1.0&q=45&auto=format&w=600&h=262&fit=crop&dpr=1 600w, https://images.theconversation.com/files/526239/original/file-20230515-23646-uevzio.png?ixlib=rb-1.1.0&q=30&auto=format&w=600&h=262&fit=crop&dpr=2 1200w, https://images.theconversation.com/files/526239/original/file-20230515-23646-uevzio.png?ixlib=rb-1.1.0&q=15&auto=format&w=600&h=262&fit=crop&dpr=3 1800w, https://images.theconversation.com/files/526239/original/file-20230515-23646-uevzio.png?ixlib=rb-1.1.0&q=45&auto=format&w=754&h=329&fit=crop&dpr=1 754w, https://images.theconversation.com/files/526239/original/file-20230515-23646-uevzio.png?ixlib=rb-1.1.0&q=30&auto=format&w=754&h=329&fit=crop&dpr=2 1508w, https://images.theconversation.com/files/526239/original/file-20230515-23646-uevzio.png?ixlib=rb-1.1.0&q=15&auto=format&w=754&h=329&fit=crop&dpr=3 2262w" sizes="(min-width: 1466px) 754px, (max-width: 599px) 100vw, (min-width: 600px) 600px, 237px"></a>
<figcaption>
<span class="caption"></span>
<span class="attribution"><span class="source">Bloomberg Finance and Bank of England calculations</span></span>
</figcaption>
</figure>
<p>Then there is inflation. The bank expects inflation to fall sharply this year and get back below the 2% target in 2024, which is good news. Nonetheless, the risks of higher inflation remains in the form of firms passing on past energy hikes to their customers via higher prices. There could well be more of this to come, so it could be that the bank is too optimistic here. </p>
<p>If so, interest rates will probably have to stay higher and the economy will have a harder time than the bank currently thinks. So while the bank is very likely a better judge of the UK economy than the IMF, there are still numerous reasons why it could be wrong on this occasion.</p><img src="https://counter.theconversation.com/content/205670/count.gif" alt="The Conversation" width="1" height="1" />
<p class="fine-print"><em><span>Luciano Rispoli does not work for, consult, own shares in or receive funding from any company or organisation that would benefit from this article, and has disclosed no relevant affiliations beyond their academic appointment.</span></em></p>The bank has set hares running by forecasting actual growth of the UK economy in 2023, while most other forecasters are more downbeat.Luciano Rispoli, Senior Lecturer in Economics, University of SurreyLicensed as Creative Commons – attribution, no derivatives.