Dr Pippa Malmgren: Super-low interest rates are not all they are cracked up to be

As the Bank of England cuts its base rate to a record low, not everyone can expect to share in the benefits 
Tradition: the colourfully-attired doorman at the Bank of England, which cut interest rates today by 0.25 per cent
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Dr Pippa Malmgren4 August 2016

Brexit gave everyone an awful fright. Business activity suffered its “biggest fall ever” so the Bank of England might cut interest rates in an effort to soothe nerves and calm the markets. But after all the turbulence the British economy has calmed down by itself. The stock market is back up. The currency has recovered a bit. In sharp contrast, assets in Italy, Spain and Portugal have come under attack.

Brexit threw a spotlight on the far larger problems that loom inside the European Union. This is a little embarrassing for the Bank, which argued that interest rates would rise in the aftermath of Brexit, when in fact they have rallied. So should the Bank have cut the rate to 0.25 per cent, the first change since 2009?

The interest rate is no mere technical matter. It serves as an instrument of social justice that balances the interests of homeowners and renters, of speculators and the savers, of rich and poor. These days the Bank of England and most other central banks are actively tilting the interest rate in favour of those who benefit most from cheap money but we need to think about what happens to the people on both sides.

A low rate means pensioners see their income fall to almost nothing. Pensions do not perform well in a world where fund managers are being asked to buy stocks and bonds at record high prices. Lower interest rates punish the poor and small-time savers while speculators are rewarded. The rich make money and the poor find their cost of living edges up. Is that what we want?

Rate cuts also weaken the currency and such devaluations make all imported goods more expensive. Devaluations are inflationary. Britain has just devalued the currency by some 10 per cent in the aftermath of Brexit and by nearly 30 per cent since the rate hikes began in 2007.

Unilever has warned that the price of goods in the shops will go up as a result of the devaluation, so keep an eye on the price of your Magnum bar, Dove soap and Domestos. You may need a cup of tea. But, note that the size of the teabag is smaller than it used to be. Did the price fall too? No, it stayed the same. Less for more, or shrinkflation, is the new game. You get less for the same price. All this signals that inflation is bubbling its way back into the economy, slowly, invisibly but palpably. This is confirmed by the OECD, which reports that the inflation rate is rising for most industrialised countries except Japan.

If you own a home low interest rates mean your mortgage is cheaper. But it is worth asking yourself whether you believe they are likely to stay at record lows forever. If not, then refinance or reconsider home ownership. The question is not whether today’s rate is affordable. It is whether the average over the lifetime of your mortgage is affordable.

Also consider why some adult kids are now called “boomerangs”. More than 50 per cent of graduates are returning to live at home because rents are rising while incomes are falling, assuming they can get a job at all.

We need to think about both sides of the rate-cut story. Note that British rents are now rising well above the official inflation rate, faster than wages and in most places even faster than in London. What happens to those who don’t own a home? Home ownership is at its lowest level in 30 years, with double-digit drops in places such as the Midlands and Leeds. The Equality Trust says nine out of 10 tenants don’t and won’t ever have the five per cent in cash needed for a deposit on a home worth £176,780. That means they are never going to be homeowners in any of Britain’s major cities, where the price of a starter home is much higher than that. In short, your children can’t move out because the rate cuts have not created more jobs but they have created higher costs.

Notice that stock markets around the world and the UK are at near record highs. That’s the point: low rates push up shares. What about other prices? It seems higher travel costs contribute to UK inflation. And wealthy parents know that school fees are rising far faster than official inflation.

Need more examples? Look at the price of every major infrastructure project in the UK. The Hinkley Point power station costs went from £14 billion to £37 billion in the past 12 months. The cost of the Trident nuclear deterrent has jumped from £20 billion in 2006 to £31 billion with a further £10 billion contingency fund in case the upward trajectory continues. There will be inquiries. But even the costs of overrun inquiries are themselves experiencing overruns. The Edinburgh Tram Inquiry costs have jumped from £899,000 to £3,708,000.

The Bank of England wants inflation. Yet by cutting rates it won’t necessarily cause inflation that much faster. Rates are already at emergency levels even though we’ve been out of the financial emergency for some years. Heaven forbid we have another emergency because the Bank of England has no place to go. Interest rates would have to become negative. In other words, the central Bank would be asking you to pay a bank to hold your cash. This is already happening in places such as Switzerland and Japan where negative interest rates are already in place. Sales of home safes there are rocketing. Burglaries might well become an issue for homeowners and renters alike if we move into negative interest rates.

The American central bank takes a different tack. It is raising interest rates in tiny steps and at an almost imperceptible pace. Such hikes or staying the course stamps the economy with the word “confidence”. Cuts stamp it with “concern”. Let’s hope the Old Lady chooses the right stamp.

Pippa Malmgren is a former economic adviser to President George W Bush and Author of Signals: How Everyday Signs Can Help Us Navigate the World’s Turbulent Economy.