Stand by for higher interest rates – but what will this do to house prices?

Global interest rates are climbing and they have a long way further to go. The only questions are how quickly they will rise and what this will mean for all of us around the world – for our mortgages, our taxes, our savings and so on.

If that sounds contentious, consider this. The world’s central banks can control short-term rates and at the moment they are nailing them down to the floor. The Bank of England’s Monetary Policy Committee meets this week and will certainly confirm that the Bank of England rate remains at 0.1 per cent. The US Federal Reserve also meets this week and will hold its Fed funds rate at 0.1 per cent. Last week, the European Central Bank kept its deposit rate at minus 0.5 per cent.  

But what they can’t do is control long-term rates. They can influence them but not control them. On Friday, the 10-year interest rate on UK gilts was 0.825 per cent, which is very low by historical standards but is up from 0.2 per cent on 31 December. The equivalent rate for US treasuries was 1.625 per cent, up from 0.92 per cent at the end of last year. And for 10-year German bonds, the rate on Friday was minus 0.3 per cent against minus 0.57 per cent on 31 December. Yes, you still have to pay money to the German government for the pleasure of lending to it; but not as much as you had to pay a few weeks ago.

It is, if you think about it, absurd to have to pay to lend to a government. It is emperor’s clothes stuff. Actually, it is almost as absurd to lend to one at 0.8 per cent or even 1.6 per cent given the aim of the central banks to increase inflation, for the more successful the central banks are at achieving their objective the more money the rest of us lose. Yet the banks have been able to get away with this, partly because they have a mandate to increase inflation and this is one weapon they think will help do so, and partly because they want to hold down the cost of servicing governments’ huge debt mountains.

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The bond markets are, for most people, arcane creatures but the increases in yields over the past few days suggest that the central banks’ ability to hold bond yields at these very low levels is weakening. As the world economy recovers, it will become weaker still.

So what will happen? No one can know the pace at which interest rates will rise or how high they will go. But it is easy to predict that the cost of servicing the national debt will climb. In the UK, the Office for Budget Responsibility pointed out 10 days ago that the government’s finances had become extremely sensitive to changes in interest rates, due to the size of the debt soaring and its maturity shortening. In round numbers, every one percentage point on interest rates adds another £20bn to debt service costs. That is almost as much as the revenue from tobacco and alcohol duties combined.  

For the US, the sums are so bewilderingly vast that the best way to think of the interest cost is simply to point out that the Federal government spends about 8 per cent of its budget on debt interest. The impact of interest rates going back to normal levels doesn’t bear thinking about. Maybe that is why people seem not to be thinking much about the costs of the $1.9tn stimulus package that has just gone through Congress.  

Rises in interest rates increase the cost of servicing national debt but they also increase the cost of servicing personal debt. So what will this do to mortgage rates and, as a consequence, house prices?

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Lender Habito One has just launched 40-year mortgages starting at 2.99 per cent. I have zero idea as to whether this is a good idea to lock into a rate for such a long period, but it does show how all this money washing around enables lenders to offer loans with very long maturities.  

Looking ahead, the central banks will fight to hold rates down. How far they succeed will depend on one thing: what happens to inflation. Not many people working now have had practical experience of the double-digit inflation of the 1970s and 1980s. In the US, the consumer price index touched 15 per cent before the Fed got it back under control. In the UK, the retail price index actually hit 25 per cent. 

Those increases were eventually crushed by double-digit interest rates. I am not suggesting we are going back there. But even “ordinary” inflation has a massive impact over the years. The Bank of England has a handy inflation calculator. I checked what £10 in 1997, the year Tony Blair became prime minister, would be worth in 2020. It is £18.61. So prices have nearly doubled over less than 25 years. And the Bank of England interest rate at the end of 1997? It was 7.25 per cent.

Stand by for higher interest rates.