How rising mortgages could derail Rishi Sunak’s election plans

Mortgage costs are going up – again. Last week’s 0.25 per cent Bank of England hike, along with the latest disappointing inflation data, suggests that interest rates will be pushed even higher in the coming months, and market rates for overdrafts, business borrowing and mortgages will follow suit. What will it mean for politics?

Isn’t inflation falling rapidly already?

Yes and no. There was certainly a sharp drop in the annual rate for April, to 8.7 per cent, down from 10.4 per cent in March, driven by lower energy prices. Even so, it was smaller than investors were expecting, and thus they will be expecting commensurately higher returns from sterling debt, meaning higher interest rates. Because of the higher reading, and the fact that inflation is becoming self-generating via higher wage rises, the Bank of England also feels obliged to choke it off by taking spending power out of the economy, meaning that businesses and retailers eventually can’t afford to raise prices again. That will squeeze inflation out of the system, and back to the 2 per cent target – but it will hurt.

How high could rates go?

Markets suggest 5.5 per cent in the short term, with mortgage rates around that level, too. If underlying “core” inflation stays stubbornly high, which means wage costs are going up too rapidly, the Bank will feel obliged to do whatever it takes to break this cycle (with a lot of political pressure, too). That might well include keeping rates at a high plateau for longer than people seem to expect; this would obviously hit business and household budgets, and the public finances, because the government is borrowing so much post-pandemic. Or rates could go even higher...

What does it mean for Rishi Sunak’s pledges?

If the Bank of England does bear down on inflation, and the chancellor supports the strategy by keeping taxes higher and not spending more on public services, then Sunak has a fair chance of keeping his promise to halve inflation during 2023 – roughly speaking, that means keeping it down to about 5 per cent. Jeremy Hunt has even said he is “comfortable” with a recession if this is what it takes to beat inflation. Sunak might just manage to return the economy to minimal growth, as the IMF and the Bank of England seem to believe is possible. But as Hunt suggests, things could easily slip back.

Sunak’s pledge on growth is thus vulnerable to a further sustained campaign of rate hikes by the Bank of England. If the base rate creeps up to 6, 7 or 8 per cent, bets are off for Sunak’s future; this would generate turmoil comparable to last autumn’s Truss-Kwarteng experiment, and would destroy the narrative that Sunak and Hunt are correcting those mistakes.

Higher rates would also drive down the value of government debt, or gilts, causing a negative effect on pension funds and possibly other financial institutions. The worst-case scenario would be another credit crunch in a world of falling gilt values, but also in a world in which the central banks can’t intervene in the same dramatic way as in past crises; they would be more restricted because of the vast debts run up during the global financial crisis of 2008-09, during the pandemic, and as a result of the Putin-driven surge in energy bills. In reality, they would probably just create the money and take the risk with inflation.

Whether this gloomy scenario materialises depends partly on domestic wage-bargaining and the outlook for the spiral of UK wage-push inflation, and partly on geopolitical factors such as the progress of the Ukraine war and tensions around Taiwan. It would help if there were no further Brexit-induced trade shocks. In other words, Sunak may meet his pledges, modest as they are, but it will still be painful, and events outside his control may conspire to humiliate him.

Who will be hurt by rate rises?

Everyone, because their impact on the economy is so pervasive. Among households, it will affect those with larger mortgages, those on tracker rates, those on cheap fixed rates needing to remortgage in the coming year or two, and mostly those in London and southeast England. Small firms will find the higher cost of working capital more of an issue than large corporations. Renters may find higher landlord mortgage costs passed on to them.

However, for those who have no mortgage or credit cards, or who have some savings, the trend towards higher interest rates will be welcome. Indexed pensions are also a bonus in such times of higher inflation. These groups are naturally older and wealthier than the general population. But older, wealthier types already tend to vote Conservative. On balance, higher mortgage rates hit younger working familIes – a key demographic for the Conservatives at this election.

And for the government’s popularity?

Given the Tories’ fairly dismal current showing in opinion polls – with vote share below 30 per cent or so – it could be argued that they’re now shrinking to their irreducible core vote, where loyalty counts for more than mere money. The Tories’ all-time nadir was the strange European election campaign of 2019, where they didn’t campaign and didn’t publish a manifesto, and scored 9 per cent; more realistic might be the 26 per cent seen in the most recent local elections in England and Wales, with Labour 9 per cent ahead.

Continuing high interest rates, combined with still-high inflation (5 per cent perhaps) going into 2024, while unemployment edges up, will make it harder for the government to plead that it is fixing the economy and that Brexit is a success.

Higher interest rates also generally add to the repayments on a sizeable chunk of the national debt, which means less scope for Hunt to deliver some election-winning tax cuts or boosts to public spending in the approach to polling day. By contrast, Labour hasn’t had to do much to generate a substantial lead on the economy, albeit the party is weak on detail. Rachel Reeves and Keir Starmer should be well aware of the severe constraints they will have to work within if they win the election.