The Bank of England’s decision to raise interest rates from 0.5 per cent to 0.75 per cent has been justified on the grounds that the economy is strengthening, employment levels are up, consumer spending is increasing, and there is little potential for real wages to increase further.
But with inflation in fact already slowing and real wages stagnating, there is good reason to question whether the Bank has got this right.
For some, the more immediate concern is that this rate rise has come soon after the Office for National Statistics announced that UK households collectively spent more than they earned in 2017 – the first time this has happened in almost 30 years. In total, the deficit was £25bn, around £900 per household or almost one fifth of the NHS budget in England.
The truth is that one relatively small rate rise will not dramatically affect the majority of UK households, but it will definitely hurt the most overstretched households that have been forced to take on debt just to get by.
Households like the 7.6 million people who owe the equivalent of at least a third of their entire annual incomes; the nearly 9 million people who are spending more than a quarter of their income on debt repayments; the 36 per cent of people with outstanding credit card debt that are were deemed just “surviving” by the Financial Conduct Authority.
Wealthy households (with collateral to put up for a loan) and high-income earners will most likely feel a negligible effect of the rate rise, if at all. And while the interest rate rise will hit struggling households the most, the UK’s biggest banks will stand to benefit – with forecasts suggesting a profit boost of at least half a billion pounds.
This all obviously puts the Bank of England in a bit of a bind. The Bank wants to raise rates, to create some room to lower them again if needed post-Brexit. At the same time, a decade of historically low interest rates has come with certain negative side effects that need reining in: rising asset prices and record levels of household debt.
And the Bank’s dilemma is symptomatic of three bigger problems that have plagued our monetary and banking system since 2008.
The first problem relates to the fact that, while wealthy households enjoy historically low levels of interest, the people who need credit the most are the ones paying the most crippling prices. These costs are in excess of any reasonable risk premium. This is why we need to protect the poorest households and cap the cost of all forms of household debt, as called for by the End the Debt Trap coalition of which the New Economics Foundation is a part.
The second problem relates to the inadequacy of the policy instruments available to the Bank of England. The Bank’s “base rate” is a broad-sweeping tool considered to have a neutral impact across the economy. But interest rate changes are far from neutral and have different impacts for different parts of the economy, both in terms of sector, geography and the income distribution. There is a good case for updating the Bank’s policy toolkit.
The third problem relates to the lack of co-operation between the Treasury and the Bank of England. For too long the Bank of England has been stuck doing the heavy lifting of trying to stimulate the economy all by itself, while the government has retracted into an obsession of balancing its books. Households have had to compensate for the fall in government spending, by taking on more debt in the process (supported by the Bank).
Needless to say this approach is unsustainable. The Treasury needs to understand that monetary policy and fiscal policy are inextricably linked. A fiscal stimulus is actually the responsible thing to do: it will undoubtedly put the Bank of England in a better policy position, while reducing the pressure on the most hard-up families to live beyond their means.
Frank van Lerven is an economist at the New Economics Foundation.
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