Lowes Magazine Issue 127

DOUG’S DIGEST

Interest Rate Conundrum

The chart below shows that the cumulative roll off for existing deals extends out to 2027.

It seems these days that there is only one topic in the news, from an economic perspective at least, which is the “cost of living crisis” caused by stubbornly high levels of inflation and how central banks continue to raise interest rates in an attempt to bring it under control. Inflation has been pushed higher in recent years by several factors, not least rising food and energy prices which rose sharply last year following Russia’s invasion of Ukraine. Whilst those prices have risen significantly, the Bank of England has more of an eye on the core inflation figure. This excludes food and energy as these prices tend to be more volatile, with food prices being affected by other events such as weather conditions affecting harvests, and energy prices being influenced on occasion by supply restrictions from producers. It also excludes things such as alcohol and tobacco, where the pricing is likely to be changed more by taxation than market costs. Core inflation is therefore considered to give a more realistic measure of price rises. Here in the UK, whilst the headline rate of inflation as measured by the Consumer Price Index, or CPI, has fallen in recent months, core inflation has continued to rise, reaching 7.1% last month, the highest it has been since 1992. This is why the Bank of England continues to raise rates despite the headline rate beginning to fall. Interest rates are raised in an attempt to cool an economy over time by raising the cost of borrowing, causing people to spend less as they use their disposable income to reduce debts where they can, and more is taken up servicing those debts they cannot reduce quickly, such as mortgages. As spending falls, so does demand for goods and services, which in turn reduces the upward pressure on prices as they have to be kept lower to compete with others. The cost of borrowing for businesses is increased also, and with costs rising while demand is slowing this can lead to cost cutting, often at the expense of jobs, again making the workforce feel less comfortable to spend money when they do not feel their jobs are secure. In the UK, however, there are several factors which mean this traditional mechanism is not working as well as it has done previously. During Covid, whilst people continued to receive an income, but their spending ability was restricted, with no-one allowed to socialise, and those working from home saving on travel and other costs. This meant that many took the opportunity to reduce their discretionary debts, such as credit cards, and came out of the lockdowns in a healthier financial position. So, for many their only real debt is in terms of their mortgage, and according to figures from J.P. Morgan less than 30% of households in the UK are currently owned with a mortgage – less than a third of all homes. In addition, a decade of extremely low and stable interest rates has changed the type of mortgage people hold. According to figures from J.P. Morgan again, only around 13% of current mortgages are floating rate, i.e. the interest rate moves when the Bank of England raises the base rate. The remainder have fixed interest rate deals, and as such have not been affected by interest rate rises, at least so far.

Types of mortgage rate at the end of 2022

Source: J.P. Morgan

60% 50% 40% 30% 20% 10% 0%

Floating Rate

Fixed, 3 to 4 Years

Fixed, 5 Years

Fixed, 2 Years or Less

Timing of the roll off of 2022 mortgage debt onto new mortgage deals

100% 80% 60% 40% 20% 0%

2023

2024

2025

2026

2027

This means that the base rate rises we have seen so far have not affected many as yet, with only around 12% of all households seeing rate rises in 2023. Rather than seeing a gradual rise allowing time to budget, however, as the existing rate deals roll off many will see a large jump in their monthly mortgage payments over the coming years. As well as the hit to personal finances being delayed by more people having fixed rate deals, the reduction in job security has also failed to materialise so far. The Brexit deal saw many overseas workers leave the UK, and alongside this Covid led many older workers to take early retirement. This meant the workforce in the UK reduced in size between 2020 and 2022, and as a result many firms found it difficult to fill vacancies. As demand has fallen, rather than having to lay people off firms have instead removed the vacancies they had but retained their existing staff. This has kept the unemployment rate at a very low level. All this makes it difficult for economists, including those at the Bank of England, to predict how increasing interest rates will affect the headline inflation rate, and this is borne out by figures in recent months being higher than predicted. Consequently, the Bank of England finds itself in an awkward position, having to appear firm in its fight against inflation, but at the same time not knowing just how much its decisions today will affect households tomorrow. There is a similar quandary in the investment sphere, with the winners and losers in the short term hard to predict. In the long term though, it will still be the strong, well-run businesses that can weather the storm and come out as the winners, and it is for this reason that we favour active asset management when it comes to selecting investment funds. If the better active managers are chosen, then they in turn can select those they believe to be the better companies that will outperform in the long term, whilst diversification will hopefully help smooth the journey in the short term. But for now, we all watch with interest how things play out in the coming months.

Lowes Financial Management and Lowes Investment Management are authorised and regulated by the Financial Conduct Authority. Visit: www.Lowes.co.uk | Call: 0191 281 8811 | Email: enquiry@Lowes.co.uk