If ultra-low interest rates are now a long-term given, what is the impact on rationale for saving and social mobility?
by Andrew Davis
When was the last time UK base rates were above 1%? Have a guess. If you said 4 February 2009 – the day before the Bank of England cut to 1%, before lopping off another 0.5% one month later – you get a gold star. Let’s hope that’s enough to make you happy because the return on your savings probably didn’t. To put it into perspective, £100 in the bank for a year at that rate earned you 50p.
This is not news, of course, but ancient history. The Bank’s base rate has been on the floor for so long that public perception of it has morphed from outrage into an uncomfortable fact of life. It’s the same across Europe, where governments charge investors for the privilege of lending them money – for all periods up to the next 30 years, in Germany’s case – and retail savings rates are zero or barely positive.
There was a time when base rates – the price of money, in effect – used to undulate with the economic cycle, rising when the economy overheated and falling when it shrank to spur it back to life. Not anymore. In a recent conversation, a senior US institutional investor remarked, “We now believe that this global rate environment is more structural than cyclical.” His organisation now sees ultra-low interest rates as a long-term given, even if the global economy were to pick up a bit. Not only was he looking back on more than a decade of extremely low rates, he was also reflecting what financial markets are telling us about the future. Money invested in many government bond markets for the next decade or more will earn less than zero.
If we accept that ultra-low interest rates are the new normal and that they are not going to rise meaningfully for a very long time, possibly decades, how does that change our view of the world? There are many implications, but here are a few possible ones to consider.
There’s no longer any point putting money in the bank to increase its value or produce an income
Super-low rates change the rationale for saving. There’s no longer any point putting money in the bank to increase its value or produce an income. Savers used to benefit from their frugality and providence by seeing their money grow, thanks to compound interest. Now they must look elsewhere for their reward. Now, saving is much more tied up with other impulses: protecting yourself against destitution if your income should dry up, accumulating money for major purchases or to give to the next generation. There’s nothing inherently wrong with this, but making it harder for savers to prosper chips away at people’s ability to change their circumstances by developing what we used to think of as positive financial behaviours. Ultimately, this erodes social mobility.
One of the main sources of social mobility since the 1980s has been increasing home ownership. But super-low rates have transformed the housing market as well. Very low mortgage rates have enabled people to borrow bigger multiples of their income, putting a floor under house prices and in some areas sending them skywards. If interest rates stay low for years to come, the chances of a housing crash that would price many more young people into the market are greatly reduced. Instead, we are more likely to see a slow-motion housing crash in which prices go nowhere for a very long period, while incomes gradually rise, eventually making property more affordable. This will probably be helped by ongoing subsidies from the government for first-time buyers.
Again, social mobility suffers because large parts of one or more generations that might once have managed to buy their home will remain priced out. News that the ‘bank of mum and dad’ is the UK’s tenth biggest mortgage lender does little to improve the outlook for social mobility. And when you hear the CEO of a major investment bank (Christian Sewing of Deutsche Bank) warning that ultra-low rates are causing a “split in society”, as happened recently, you can be confident that the game has changed.
Finally, what about the rules around debt? If more people need mortgages for 30 or even 40 years so they can afford to buy a home – and the age at which they make their first purchase continues to rise – how easy will it be for them to move later in life, for example to take a new job? Mobility, this time labour mobility, could become more of a problem, affecting the functioning of the economy as well as individuals’ career prospects.
Things may turn out better. But the only safe bet, to my mind at least, is that we should plan on the basis that interest rates will not rise significantly for many years to come.
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