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Mortgage rates are rising whilst the Bank of England’s Quantitative Easing is supposed to cut them

Mortgage rates are rising whilst the Bank of England’s Quantitative Easing is supposed to cut them Mindful Money

Today I wish to return to a subject that was the second theme I established when I began this blog back in November 2009. It was that there was a developing gap between official interest-rates and the interest-rates faced by borrowers, savers and businesses which I called unofficial interest-rates. A factor in this was the lack of competition in the UK banking sector which I illustrated back on the 3rd of December 2009 with the number of building societies in the UK.

  • 1989 there were 110
  • 1999 there were 69
  • 2009 there are 52

  • At the time I wrote that the number was about to shrink again as the Yorkshire and Chelsea Building Societies were about to merge. In the banking sector we had seen a similar reduction in competition where at one stage mergers such as that between Royal Bank of Scotland and National Westminster Bank were seen by some as the cutting edge of banking. What happened to them? And even in the credit crunch era the last UK government proved that it was no fan of competition by encouraging the disastrous merger between Lloyd’s Bank and Halifax Bank of Scotland.

    What did this create?

    I pointed out even then that we were seeing a much higher level of mortgage rate for a given level of official base rate which even then was at 0.5%.  I went on to point out that the 0.5% base rate was therefore likely to have a much weaker effect on the UK economy than econometrics and many “experts” might have you believe.

    So for an individual taking out a new mortgage the effect under the old system is for a base rate of at least 2.5% and maybe 3.5%. I hope that I have your attention now as interest rates for mortgages are offsetting much of the cuts the Bank of England has made in the UK base rate. It is my opinion that for this reason and other similar movements in other types of borrowing that we can expect the interest rate cuts to have much less of an impact on the UK economy than economic models would predict.

    I think that the forecast there has in fact turned out to be true over the following 2 and a bit years where we have seen only a weak recovery. By contrast conventional economic theory had been predicting economic effects from a 0.25% move in base rates and so would have been expecting some sort of economic nirvana from a cut of over 4%. One consequence of this is that the “emergency” 0.5% base rate from the Bank of England is now 3 years old, although according to my developing financial lexicon it can still be described as temporary (any event between now and the end of time).

    More Competition was needed even then

    I did have a policy prescription which was to encourage more competition and I would have started by breaking up what has become called the Lloyd’s Banking Group as described below:

    "For example there are two old building societies within it, these are Cheltenham and Gloucester and Birmingham Midshires. These could be spun off and recreated as building societies and return to their “old” business of retail savings and retail mortgages to help provide more competition."

    I also suggested a remutualisation of Northern Rock with its members buying it off the taxpayer over time and would have encouraged other players to join the industry. Although mind you according to the blog Left Foot Forward the “bad bank” part of Northern Rock will not only make profits but “this will be generated every year going forward”. The emphasis was theirs and I await their installments on cold nuclear fusion and perpetual motion which are about as likely! Will they share their crystal ball?

    The latest consequence of this is the move started by Royal Bank of Scotland

    Last week RBS raised the mortgage rate on two of its mortgage products as it raised it interest-rate variable rate on them from 3.75% to 4%. This is interesting as its own website tells us this.

    Your Variable rate loan will be linked to the RBS Base Rate which is influenced by changes in the Bank of England Base Rate.

    Yes the rise is influenced by something which has not changed for three years and when it did it fell!

    If you have little competition then you might call it a cartel

    A couple of days later we heard this from the UK biggest mortgage lender.

    Halifax, the UK’s biggest mortgage lender will raise its SVR from the May 1st from 3.50 per cent to 3.99 per cent.

    They tell us that this has been forced upon them by events.

    Halifax said it had made this decision because of the higher cost of raising funds for mortgages from both savers and the financial markets.

    Is this true?

    Let us go back to December 2009 when I looked at the retail savings market.

    Until this weekend it was possible to invest money on a one year basis with National Savings (backed by the UK government) and get a gross return of 3.95%. Some savings institutions are offering rates of around 3% on instant access.

    Checking this morning unless you have £50k to invest the best instant access savings rate is 3.1% and the best one-year savings rate is 3.65% (h/t MoneySavingExpert). So what change there has been there has mostly been in lower fixed rates. Not quite what we are being told is it?

    Now let us take a look at financial markets and we immediately face an elephant in the room. It is called Quantitative Easing and the Bank of England has spent some £288.2 billion on it so far and plans to buy another £1.5 billion of UK Gilts (2027-60) this afternoon. What will this achieve according to its website?

    That lowers longer-term borrowing costs

    Er the same costs which banks are telling us are rising? Somebody needs to get a grip here!

    If we look at the UK Gilt or government bond market we see that from when I looked at this in December 2009 we had a ten-year yield of 3.5/3.6% whereas right now it is 2.15%. If you argue that three-year money is more relevant then we had circa 1.7% then and 0.54% now. You may have spotted that these are down and not up! Care is needed here as countries that have not had QE have also seen a fall in bond yields and it is a long way from the full explanation but having made that point let’s move on.

    Cheap Money from the European Central Bank (ECB)

    The ECB has been offering rather cheap finance recently and UK banks took some 37.4 billion Euros at an initial rate of 1% over three years over its two offers. The fact that this rate is not fixed, may well be a benefit as the next ECB rate move could easily be down.

    If we look at the Halifax which if you recall raised it mortgages due to “rising interest-rates” it’s parent bank Lloyds in fact borrowed some 13.6 billion Euros and I await its explanation of how being able to borrow money cheaper than ever over such a period is in fact a rise!

    Is the Business Secretary Vince Cable asleep?

    As these two banks are either owned by the taxpayer (RBS) or taxpayers are the biggest shareholders (Lloyds) one may wonder where our government has gone! Apart from that may I suggest the Business Secretary looks into a situation which looks like a cartel.

    Of course the lack of action so far may indicate that in a regular theme banks are more important to the government than their customers.

    The economic effects of this

    1. There will be a clear reduction in demand in the economy as around 1.1 million mortgage holders (850,000 Halifax,200,000 RBS) see their monthly mortgage payments rise. This will be added to by the 0.1% increase that Santander has made on some mortgages. In these times of restricted supply it is not easy to switch and for many because of current valuations and net equity it will be impossible. In terms of scale this compares to around 7.7 million total mortgages.

    2. Higher mortgage rates are likely to have a depressing effect on house prices in the UK. According to today’s data from the Halifax house prices fell by 0.5% in February and are 1.9% lower than a year ago.

    3. There may be an offsetting rise in bankers bonuses but this is hard to measure accurately.

    4. Our two inflation indices will diverge as the Retail Price Index includes mortgage interest payments ( in 2011 some 3.2% of the RPI,although rising mortgage rates will raise the percentage too).

    5. We have yet another situation where reality diverges from the official view. Whilst central bankers pump cheap money into the economy and hold official short-term interest-rates at all time lows this is having less and less influence on the interest-rates individuals and businesses face. The transmission system which is our banking sector is simply broken and needs repair but of that repair there is no sign.

    As we have had a Labour administration and now a Coalition one (Conservative and Liberal Democrat) we can see that whatever the government in the UK our banks are singing the words of Pete Townsend.

    Meet the new boss,same as the old boss

    This article was written by Shaun Richards and originally published on Mindful Money under the title: Does it bother only me that mortgage rates are rising whilst the Bank of England’s Quantitative Easing is supposed to cut them?

    Tags: Bank of England , banking , banking reform , banks , Euro zone Crisis , eurozone Crisis , Extraordinary Monetary Measures , General Economics , Gilts , inflation , interest rates , Issues , mortgage note , mortgage rates , mortgages , Prospects , quantitative easing , quantitative investment , RBS , UK Inflation
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