Bailey’s miscalculation could kill lower end of housing market for a generation

It’s great that at last the grown-ups are back, less great that we now know we’re all going to have to pay more tax and that the government will impose even more draconian cuts on public services than they’ve done for the last 12 years.

We know, too, that much of this new austerity is a result of Covid, which cost around £400bn, and Putin’s war in Ukraine, which has cost another £150bn to keep people out of fuel poverty. But now comes the reckoning. The economy has to get back to some form of fiscal discipline after a decade or more in which we wallowed in ultra cheap money.

The next couple of years at least are certainly going to be tough. But there’s one player in this complex game of high finance whose position I simply don’t understand and I’m not alone. Professor David Blanchflower, a globally respected economist, who for three years was an external member of the Bank of England’s Monetary Policy Committee, has said quite openly that rather than raising interest rates, Andrew Bailey, the current Bank governor, should actually be lowering them.

I don’t go that far, but I do believe the recent rises have been far too quick and hugely damaging as a result. Just to remind ourselves, the bank rate in 2013 was 0.5%. It dipped to 0.25% in 2016 before rising to 0.75% in 2018. In 2020, rates were down to 0.1%, but then from February this year rates shot up from under 1% in May to a staggering 3%.

Staggering is a strange word to use for anyone over 50 who remembers when systemic inflation was the country’s biggest challenge, and some of us remember paying double figures for our mortgages, but in the context of today’s market, more than trebling interest rates in a matter of a few months is going to have a catastrophic impact on young homeowners.

Over a million of them will see their fixed rate mortgage repayments increased massively to the point when, if no action is taken, we are going to see tens of thousands of owners throwing their keys back at their lenders having been wiped out. Their repayments will be completely unaffordable, their deposit swallowed up and their personal wealth destroyed.

Help to Buy has already given them a false sense of value, but this will be far more damaging. Lenders will probably have to extend terms, increase repayments to whatever the borrowers can afford and back end the difference. That itself has its own consequences. It will make it impossible for those owners to move when baby arrives, because they just won’t get their money back. They are simply locked in.

The underlying issue is why the Bank of England saw fit to raise interest rates so precipitously. Bailey says it is a response to the current rate of inflation, but this is frankly nonsense. Historically, inflation was caused by the eternal cycle of wages chasing prices chasing wages. The Bank used interest rates to put pressure on spending by raising rates and encouraging spending by lowering them.

This inflation is totally different. It is Putin’s inflation, which having peaked at just over 10%, is likely to fall to nearer 2% within the next 12 months. Raising rates to put pressure on spending is cruelly inappropriate. Most people are already counting every penny. Domestic spending is not the issue and Bailey must know this.

The Bank’s long-term plan was always to raise rates to 3%, but the assumption was this would be by 25 basis points every three or six months. On that basis, the current crisis could largely be afforded. Getting there in a matter of months is a massive miscalculation and it could be the one that kills the lower end of the residential property market for a generation.