Is the era of cheap money coming to an end? If it is, then you cannot say you were not warned. The world and his wife were anticipating a quarter-point increase from the monetary policy committee last week. They were not disappointed. The Bank of England delivered according to expectations. Equally unsurprisingly, mortgage lenders were quick to follow suit. The real question is, where do interest rates go from here?
The level of interest rates is not just about how much your mortgage costs. Savers depend upon deposit interest. Indeed, the bear market of 2000 to 2003 has probably resulted in more money finding its way into deposit accounts than might otherwise have been the case. The level of interest rates will also impinge upon annuity rates and thus funding requirements for pension funds. Borrowers are not the only people affected when interest rates change.
Although we had double-digit interest rates a dozen years ago, the reality is that we have adjusted to cheaper money very quickly. The really attractive rates, for borrowers, that is, were around a year or so ago.
In the dying days of the equity bear market, not only were short-term interest rates low but long-term rates had also taken a dive as money poured into Government stocks. Indeed, you could argue that the brief restoration of the yield gap, when the yield on equities rose above that on gilts, marked the end of that bear market.
How high could rates go in this country? It depends on which particular concern is driving the MPC at the time. If it is our competitive position in the export market, then rates may not rise very far from here. Already, sterling is strong against both the dollar and the euro so pushing them up to the point where we are more than double the European level and four times that in America can only serve to exacerbate the situation. Exchange rates are, of course, a concern but the housing market and the British propensity to borrow are probably the real drivers.
Data out last week on house prices suggested that bricks and mortar are still delivering sterling returns. Indeed, the Halifax reported that January's rise was a whopping 2.2 per cent – the biggest monthly advance in house prices since 2002. Even the Financial Times House Price index, which endeavours to take account of all house price movements, not just those funded by a mortgage (which is the case with the Halifax and the Nationwide indices) indicated that house prices were 13 per cent higher at the end of January than they were a year previously. To dampen down this sort of rise could result in interest rates rising by perhaps as much as another 1.5 per cent. That really would have an effect.
It would be difficult to justify such a move based upon inflationary pressures alone but the reality is that the housing market had already priced in last week's quarter-point rise. Even a further half point may not be enough to cool the ardour for borrowing against the value of a rapidly appreciating asset. That is the concern that markets should have. Rate rises of this magnitude will impinge elsewhere in the economic recovery. It is not only housebuyers and consumers that borrow. Businesses do, too.
Will the level of overseas interest rates have much effect? In Europe, which arguably is more important to us here, there seems little prospect of rates rising. Indeed, some muttering about a possible ECB cut to keep the tentative economic recovery in Germany and France from stalling has been heard. In America, on the other hand, where economic growth now seems back on track, the era of very cheap money may soon come to an end. At the very least, the Federal Reserve Bank has called the bottom. Quite how far rates will rebound from their present 1 per cent is debatable, though.
We have seen the turn in interest rates in this country. What we do not yet know is the extent of the retracement that will take place and the effect it may have on the wider economy. The MPC minutes, when they are published, will give us more of a clue.
Perhaps the MPC really is concerned that the consumer price index, presently languishing at 1.3 per cent against a target of 2 per cent, could be on the way up as far away as two years time. But for my money, it is the housing market that is providing the real concern. Rates may have a way further to go yet.