Yesterday marked the tenth anniversary of the last time the Bank of England raised interest rates. We’ve lived through a decade of exceptional monetary policy. This has achieved little in terms of fixing the structural imbalances in the economy caused by excessive debt. British consumers have not taken, or been able to take, full advantage of historically low interest rates to pay down their debts in preparation for the next inevitable downturn. Judging by recent trends in economic that downturn could soon be upon us and British homeowners appear to be poorly prepared.
In its latest quarterly release, the Office for National Statistics reported that the savings ratio hit a record low. The savings ratio measures the outgoings and incomings of domestic budgets of British households. This ratio is an excellent barometer of consumer savings behaviour in the UK. It is also just one of a number of indicators, which suggest trouble is coming.
Falling for the last year, the savings ratio implies that more and more British households are struggling to cope with climbing prices and sluggish wage growth. If this trend continues there are serious implications for the economy and house prices. The less British consumers are saving the less well prepared they will be for higher mortgage payment costs, when interest rates inevitably start to move higher.
The Bank of England claims the British inflation rate is 2.9%. Anyone who has been paying attention to the size of his or her weekly shopping bills will know that this is an underestimate. With Sterling suffering the persistent effects of its Brexit hangover, its weakness looks set to continue. This will put further upward pressure on day-to-day living costs. The longer this continues the less able the Bank of England will be to maintain its fantasy inflation reporting. Market dynamics will force it to adopt a more “normalised” monetary policy, which means it will have to raise interest rates.
This is when the trouble could begin.
It is not a great logical leap to suppose that those homeowners who are already unable to save also (for the most part) maintain interest only mortgages. If this assumption is correct, these same homeowners could find themselves in difficulty quite quickly if there are hit by an unavoidable additional monthly cost. Since mortgage lenders will almost certainly immediately pass on any rise in interest rates straight to their customers (or even potentially do so in anticipation of a rate rise), a significant proportion of the population could swiftly find itself unable to pay for the homes it currently occupies.
If this happens it is not inconceivable a flood of property could suddenly engulf the market, triggering a housing crash.
This might all sound very alarmist, but consider for a moment another recent news item about the Bank of England. It was only a few days ago that the Bank beefed up its reserves requirements for British banks to deal with bad loans over the next eighteen months. The banks now have to set aside an additional £5.7billion over the next six months and then a further £5.7billion by the end of 2018. Given the Bank of England’s impressive record of underestimating risks to the economy, these increased measures are a cause for concern.
If the situation is bad enough that the Bank of England believes an extra £11.4billion will be needed over the next 18 months to cover bad debts, just how much trouble are we really in?
According to the Bank’s Financial Policy Committee, consumer credit grew at 10% last year, far outstripping wage growth. Annual rage growth is currently running at 1.7%, the lowest level since January 2015. This is another obvious warning that all is not well among British home-owning consumers. Not only are they not saving, but they are also borrowing more. And not only that, but the Bank of England also expects these same overly leveraged consumers to start defaulting more on their debts over the next eighteen months.
So what does this mean for investors?
In the short to medium term, probably not a lot.
The problem with identifying macro-trends, which seem to be on an irresistible march to an inescapable dramatic conclusion, is that they are nearly impossible to time. Only a tiny handful of investors will call the top of the housing market correctly, and they will be bloody lucky.
With inflation threatening to spiral out of control, the Bank of England finds itself in a desperate spot. If it maintains its near zero interest rate policy for too much longer then the inflation genie could escape the bottle. However, the Bank also knows that as soon as it starts to raise rates this could have a devastating impact on overly leveraged homeowners and therefore the property market.
Only impossible choices lie ahead and at some point there will be a reckoning. When this happens the smart money will be positioned, ready for what could prove to be the land grab of the Century.