The vast majority of Britons are borrowers or savers. Many, perhaps surprisingly, decide to be both at the same time. Therefore, what happens to interest rates over the coming months really matters: it is one of the key determinants for household spending and business investment.
For most of the last decade, interest rates largely headed in a single direction – down. At the start of 2008 the average deposit account paid a rather perky interest rate of over 5 per cent. By the end of last year that had plummeted to just 0.8 per cent. Over the same period, the average mortgage interest rate fell from more than 6 per cent to under 2.5 per cent.
When the drama of the post-financial crisis period is eventually written, the victor will be most easily cast as a borrower; the role of victim, more suited to a saver. For many who admire the virtues of thrift, this feels like the wrong way around. Policymakers trying to make sense of ongoing frustration with modern capitalism should consider the moral injustice of punishing the prudent and rewarding the reckless. Speeches about how much worse it could have been had interest rate cuts not acted to support the wider economy will do little to change this perception.
But economic forces, and with them monetary policy, are now slowly shifting. UK interest rates set by the Bank of England have been raised twice during the last nine months. This is starting, albeit too slowly for some, to translate into the best buy tables for mortgages, loans and current accounts. As this is the first period of interest rates that many younger households have ever seen, it is understandable that there is both caution and curiosity about what now happens. The former Bank of England Governor, Lord King, liked to say that central banking should aim to be boring. But there is nothing boring, nor predictable, about trying to understand the impact of interest rates moving up from levels not seen for at least 5,000 years.
For businesses and households across the UK, guessing what comes next is far from straightforward. Will the UK follow in the footsteps of the United States which, later this month, is likely to see its eighth interest rate increase of the current cycle? Or will the economy find itself tethered to its European neighbours. where central bank interest rates remain at zero or negative across 22 EU countries?
The case for a fast increase in rates is largely one born out of fear, rather than optimism. There are concerns that the ongoing optics of a fractious Brexit will mean that lenders to the UK government will begin to demand higher interest rates to purchase a stake in the UK’s £1.8 trillion debt pile. In the week that the Argentinian central bank was forced to raise interest rates to an eye-watering 60 per cent. The experience of Argentina, in the week that its central bank was forced to raise interest rates to an eye-watering 60 per cent, acts as a salutary tale to observe what can happen if heavily indebted governments cease making rational economic decisions.
However, the case for a slower pace of rate increase is more persuasive. Indeed, financial markets are already betting that any further increase in Britain will be rather limited. Recent investor behaviour suggests no more than two 0.25 per cent increases are expected in the UK over the next three years. By any historical comparison this is abnormally slow. It is set to be a case of lift-off, rather than blast-off. While these expectations can be volatile, the smart money - and indeed most of the dumb stuff - is that changes to the fortunes of borrowers and savers will be gradual. However, what sits behind this likely gradualism tells us much about the current state of the UK economy.
To begin with, the recent pick-up in consumer spending that coincided with the football World Cup and a warm, dry British summer has begun to fade. It has done so in synchrony with the temperatures and the quality of the England cricket team’s batting. Furthermore, higher petrol prices have begun to eat into disposable income. Savers, having perhaps tired of pitiful returns, are putting aside less than at almost any time in the past 60 years. Importers are also beginning to revise their prices higher due to the renewed fall in the value of the pound. This condition of higher prices and subdued consumer spending is known as stagflation. Stagflation is very hard for interest rate setters to respond to, with economic growth and inflation suggesting very different policy prescriptions.
This uncertain domestic backdrop is, however, only part of the story. Further afield, inflation and growth remain subdued in Japan and the eurozone. The Chinese economy is now slowing as its government seeks to deter risky lending and worries grow over an escalating Sino-American trade war. Should these large economies respond, as is most likely, by keeping their own interest rates low, then even modest interest rate increases in the UK will attract sufficient inflows to fund the UK’s twin deficits. Whilst the desire to take back control of our economic and political destiny has sound logic, modern economies with increasingly free moving capital have their economic destinies heavily influenced by factors beyond their control.
The final reason for such gradualism is that many of the factors that necessitated lower interest are still playing out. The advent of technology allowing consumers to compare prices instantly limits the ability to raise prices for many firms. A progressively ageing population means less demand for borrowing and risk-taking. This continues to weigh on the interest rate needed to balance the flow of savings and investment.
There seems little doubt, however, that the decade of ever lower rates is drawing to an end, but all the signals suggest that the path back to anything resembling normal will be a slow one.
A version of this piece was published in The Times.