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Why nobody is interested in rising interest rates

·3-min read

“Pessimists are usually right and optimists are usually wrong,” Thomas Friedman wrote, “but all the great changes have been accomplished by optimists.” Contemporary politicians have taken note. Voters reward boosterism with high office, whereas dour experts rarely make it onto the ballot paper. So we elect Boris Johnson, but leave it to Andrew Bailey, Bank of England Governor, to deliver all the bad news.

Might there be some wisdom in shunning doomsters? Take inflation: the more we talk it up, the more probable it is to come about. Likewise, the more Bailey shouts “recession” from the rooftops, the more likely businesses are to anticipate a slowdown, and thus rein in investment.

Such pessimistic predictions are, in the parlance, performative utterances: stating them helps to cause the very thing we want to avoid. So it is that while experts are warning us that energy bills are set to top £3,300 as I wrote a couple of weeks back, many households still have their heads in the sand. Closer to home, when my company delivers free personal forecasts, users often flatly refuse to believe them, sure their cost-of-living increases can’t be as large as we predict.

And many are proving similarly oblivious to the effects of the inexorable rise of mortgage interest rates.

Since 2007 asset owners have enjoyed an extremely unusual period in which central banks throughout the world pumped enormous amounts of liquidity into the economy through programmes of quantitative easing. Like many natural experiments in macroeconomics, it’s really hard to know the precise effects of this. But an epoch of low interest rates has very probably caused a dramatic and sustained increase in the market price of the asset most of us care most about: house prices.

It seems counterintuitive to say that low interest rates should increase the price of property. Surely it’s because there aren’t enough houses? Sort of. But it isn’t an absolute constraint on the number of houses that matters. If you could really live anywhere then there are plenty of affordable homes in the UK. Most of us, though, can’t just relocate, which is why housing is expensive.

Because location is so important to the amenity of a property, what mainly determines the amount I am willing to pay for the bit of land I like is typically the amount I can afford to pay. For housing, that is usually a function of how much debt I can raise – which is, in turn, a function of interest rates.

In equilibrium, therefore, lower interest rates mean higher house prices.

Now that Messrs Bailey et al are raising interest rates to tame inflation, and will keep doing so, house prices will start to come down – other things being equal (which, in economics, they always are eventually).

Soaring inflation will mask this effect somewhat. Consider: if inflation were to persist at just half its current level, then a £500k London flat I bought today and sold a decade hence for exactly the same price would actually have lost me £200k in real terms.

But such comforting optical illusions aside, falling house prices will make people feel poorer. Many will struggle to refinance. It will lock others into negative equity. Some will default (indeed, my sources tell me that lenders are already staffing up in anticipation of a huge rise in delinquency from this autumn onwards).

Nor, sadly, will lower prices help aspiring renters: interest rates being higher, first-time buyers’ affordability will be similarly curtailed.

All of this will badly sour consumer sentiment and that exacerbates recessionary pressures. It will cause great hardship and upheaval for many families. I don’t know whether that hardship is better or worse than the real and present harms of inflation: the Bank of England Monetary Policy Committee has the most unenviable role in having to choose among the lesser of two evils.

But before you decry experts and call for accountability, or demand a public debate about their choices, remember: the more they talk about it, the less we’ll like them. Oh, and the more they talk about it, the worse it will get.

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