Investment Markets » Banking and Finance
An Interest Rate Hike Too Far?
Fears are growing that the Bank's monetary medicine is in danger of killing the patient.
No one can say we weren't warned. The Bank of England's decision to raise interest rates a quarter point to 5.75% – its fifth hike since August – was so widely flagged that there was a sense of bowing to the inevitable.
Indeed, had Governor Mervyn King and his team failed to administer their dose of bitter but necessary medicine there would have been consternation in the City, where financial markets have already priced in rates of 6% or above for the next year.
With household finances looking dangerously stretched, the Bank is engaged in the most precarious of high-wire acts. But its priorities are clear. It considers a slowdown in the economy a sacrifice worth making to bring inflation to heel.
The outlook is darkening for a nation so engulfed in debt (£1,300bn and counting) that the pain of higher interest charges is certain to push many troubled borrowers over the edge. The upward spiral of property values – up 155% since 1997, compared with just 18% in wages – has driven people to max out.
Interest rates have merely reverted to the historical norm, but the percentage of household income now devoted to servicing debt is 19% – above the level in 1990; some in London are paying half their salaries in mortgage charges.
Given that it takes some 18 months for monetary tightening to bite, there's clearly more hardship to come. Particularly worrying is the time bomb of some two million mortgage-holders whose fixed-rate debts will shortly expire, exposing them to all five rate hikes in one gulp.
The credit boom has encouraged many to go into debt as never before. The result is a consumer economy entering unchartered territory. If the Bank is not already in overkill territory, it is close.
Yet there are weighty arguments in favour of continued tightening – not least whipping Britain into shape to withstand the next global recession. The most disturbing statistic is that the savings ratio is at its lowest in 47 years; raising interest rates is a crude, but eventually effective way of tackling this.
Then, of course, there's inflation. UK headline figures might be down, but the monster is far from vanquished. The game is up for the main factor keeping global inflation in check: the so-called China Effect.
Higher wages in emerging economies have reversed the trend for ever-cheaper manufactured goods, just as demand for raw materials is pushing prices up across the board. The world's central banks have jammed on the brakes. We will find out in 2008 and beyond whether they have left it too late.
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