Thursday, 30 June 2011

The Curse of Low Interest Rates

The Bank of England's Monetary Committee was this week split but Interest Rates have again been held at record low levels of just 0.5%. Surely this is good news for us all and the economic recovery?

The reality is that there is a ticking bomb in the system as those people who either are already on standard variable rate (SVR) mortgages or are due to be on them soon, have a nasty shock in store. The fact is that interest rates will rise - it's just a matter of when not if. SVR today is from 3.5% to 4.95% and many people have budgeted the affordability of their mortgage and lifestyle based on this rate. If base interest rates should raise by just 1%, then it would constitute as much as a 29%% rise in SVR and, therefore, repayments which is a huge increase. And let's face it, given past SVR levels, a 1% rise is trivial.

The saviour for people in this predicament in the past was to grab a fixed rate mortgage around now and lock themselves down on repayments. But the problem is that new fixed rate offers are factoring in what banks think will happen to interest rates and in many instances these deals are unaffordable already for people on SVR. There is a ticking bomb in terms of potential repossessions in the future.

The indicators in the economy are not good. The retail sector is suffering as 4%+ inflation rates hit. Jane Norman, Thorntons, TJ Hughes, Carpet Right, Habitat amongst others have suffered terminally in a raft retail of bad news. And only part of this can blame the internet changing buying habits or out of town shopping growth. You can tell when it gets tough when affluent London commuter towns like St Albans have boarded up shops in the High Street and Poundworld is the most thriving shop. Consumers are already reining in their credit exposure and spending. The news gets worse as only yesterday British Gas spoke of yet another hike in gas prices of around 20% as a strong possibility and we already are seeing upward pressure on food costs.

The fact is that inflation figures are misleading. The real inflation rate amongst people with average or lower disposable incomes is actually much higher as those goods which are increasing in price faster represent a higher proportion of average spend to these people as it may do to richer people. The rising cost of energy hits average incomes much harder than higher incomes as these people may spend the same on energy but it is less of a proportion of their average spend than lower paid people.

And today, Public Sector workers are striking over austerity measures which threaten their pensions which are gold plated compared to the real world of the Private Sector. But here's another reality. The Government does not invest lump sums over the long term 'saving and investing' to pay for Public Sector pensions, they actually come out of the current account paid for by National Insurance. So Public Sector pensions are paid directly out of our taxes, there is no magic fund or annuity to pay this. You and I, everyone, pays for Public Sector pensions directly in our tax bills today - and this is only going to get higher. So while in the Private Sector we have a crisis looming in terms of retirement income, we are paying for the gold plated, premium Public Sector pensions in our tax.

And the Public Sector workers think we will support their strike? They must be joking.

So people stuck on SVR mortgages have it in all directions - higher interest repayments to come, more taxes to pay for Public Sector pensions and the like and higher inflation on staple goods. It's not a pretty place to be. Add in greater uncertainty on jobs, particularly in the banking and retail sectors and the picture is very gloomy.

In many respects, the damage caused by the economic disasters in the financial sector has yet to really bite. The next 24 months could see some very tough times and a band of people are right in the firing line. By keeping the interest rates low to kick start the housing market, many people who got new mortgages based their affordability assumptions based on lower interest rates continuing.

This is the curse of low interest rates.

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