Homeowners feel the pinch from interest rates

Jul 11 2007 by Tony McDonough, Liverpool Daily Post

LAST week’s decision by the Bank of England’s Monetary Policy Committee (MPC) to raise UK interest rates to 5.75% – the highest level for six years – was seen as a necessary move in the battle against inflation.

But the dry economic rationale put forward by experts in favour of the rise is of little comfort to the homeowners across the country who now face soaring mortgage payments.

The MPC is attempting to slow consumer spending by making it more expensive for people to borrow money through personal loans, credit cards and, increasingly, through the remortgaging of property.

Businesses and financial markets will eventually feel the effects, too. Lower consumer spending means lower profits and as the price of borrowing rises companies will become less inclined to borrow for major acquisitions or capital projects.

Bank of England deputy governor John Gieve said yesterday the main question for monetary policy was whether the central bank had done enough to bring inflation back to target.

“The issue for me is ‘Have we done enough to bring inflation back on a sustained level of 2% in the long term’,” he said.

“We have seen inflation well above target for most of the last year. It is now coming back quite sharply as gas price increases of last year fall out and we get some gas price decreases.

“There are some signs that the past interest rates may be coming through in consumption and housing, but it is not clear-cut yet.”

Paul Williams, a director at Liverpool stockbrokers Blankstone Sington, believes the trick to successful monetary policy is for the policymakers at the Bank of England to ensure there is a “soft landing” – that is to gently slow down economic activity, without pushing the country into recession.

He added that the consensus among economists was that the best way to achieve this would be one more rate rise, to 6%, by Christmas.

Mr Williams told the Daily Post: “The Government has charged the bank with keeping inflation under control. Its remit is for the UK to have a CPI (Consumer Price Index) of 2% over any two-year cycle.

“Any deviation of 1% or more from this target level requires a public letter from the bank to the Chancellor of the Exchequer explaining the reasons behind its failure to meet the target. The bank had to do this in March of this year when the CPI hit 3.1%.

“The inflation rate has subsequently drifted back to 2.5%% but still remains above its target level, and with economic growth rising faster than expected in the first quarter the bank feels further monetary tightening is necessary.

“Making it more expensive to borrow money (eg, higher mortgage costs, higher interest rates on credit cards, etc) has the effect of slowing consumer spending.

“Less demand for goods and services makes it more difficult for the sellers of these goods and services to put prices up. Hence the rate of price inflation is slowed.

“One of the main drivers is the housing market. Many fixed-rate mortgage deals expire this year and will be replaced by more expensive deals. Increases in mortgage costs should slow the housing market down and reduce further the already decelerating rate of growth in house prices.”

Mr Williams added that interest rates will also eventually have an effect on the stock markets.

“Share prices have continued on a rising trend despite the increase in interest rates, but eventually speculative activity is dampened down thanks to more expensive money,” he said.

tonymcdonough@dailypost.co.uk