Low rates seem here to stay — thanks to older savers

We shall see. But returning to interest rates — the monetary weapon that people most notice — you will recall that the official rate was cut to 0.1 per cent in two steps in March last year as the pandemic hit. The pre-pandemic rate was 0.75 per cent, which also happened to be the highest since early March 2009.

You read that correctly. For more than 12 years, official interest rates have been below 1 per cent. For younger readers, this will seem like the norm. Older readers, who recall interest rates well into double figures, may still be rubbing their eyes in disbelief.

There have been periods before when Bank rate has been becalmed, at 5 per cent from 1720 to 1821 and 2 per cent from 1932 to 1950, though never at levels as low as now. In fact, until the financial crisis over a decade ago, Bank rate had never been below 2 per cent even though it has been around since 1694.

The view at the time was that this was, in the jargon, its lower bound, due to the potential damage an even lower rate would inflict on the banking system.

Financial markets do not expect this low-rate regime to end soon. Economists at Deutsche Bank in London have brought forward their expectation of the first post-pandemic rise in rates, but they do not expect it to happen until August next year, with an increase to the heady heights of 0.25 per cent.

Thereafter, Deutsche expects two quarter-point increases in February 2023 and May 2024, taking the rate to 0.75 per cent, which you will recall is the highest it has been since early 2009. That will mark the end of the tightening cycle, they say, with no need to increase further to keep inflation under control.

For those of us brought up in an era when interest rates could go up by two percentage points or more in a single day, this kind of ascent seems painfully slow. Compared with the mountains of the past, a molehill is in prospect.

It is also painful for many older people. In the debate over honouring the triple lock on pensions, despite this year’s hugely distorted average earnings figures, many pensioners point out that low interest rates mean they have lost out on most of the savings income they used to rely on.

Low interest rates benefit borrowers, who tend to be younger households.

To add insult to injury, perhaps, one member of the MPC, Gertjan Vlieghe, in his final speech as an external member of the committee, argued that an ageing population — and the tendency of older people to keep their growing wealth in safe, or risk-free, assets — is a significant factor bearing down on interest rates. This process began 30 years ago and, he argued, has further to run.

“We are only about two thirds of the way through a multi-decade demographic transition that is affecting interest rates,” he said. “Absent policy changes, there is no prospective reversal in this particular driver of interest rates.”

There is often a focus on household debt, but it is outweighed many times over by household wealth. Aggregate household wealth in Britain, net of borrowing, was £14.63 trillion in the latest estimates — including £6.1 trillion in private pensions, £5.09 trillion in property wealth and £2.12 trillion in financial wealth.

Wealth is plainly not evenly distributed, but that works out at more than £540,000 per household. It is skewed towards older households. And, as Vlieghe observed, the old life-cycle assumption that people build up wealth in the run-up to retirement and then run it all down does not work: “The higher saving of the middle-aged outweighs the modest ‘dis-saving’ of the retirees.”

The wealth and savings of older households are not the only factors pushing down on the neutral rate of interest, but they mean current ultra-low rates are not just the consequence of a cautious MPC being unwilling to take a risk with rate rises. The implication is that even if the Bank wanted to increase aggressively, it would soon find itself with interest rates above the levels necessary to hit the 2 per cent inflation target and maintain economic growth.

These things can never be set in stone. In the 1950s and 1960s, few would have thought that interest rates in double figures would soon become the norm. We will hear more from the Bank this week, but it is set to confirm its view that the current inflation shock, which could push the consumer prices measure up to 4 per cent later this year, is temporary.

Were that not to be the case and the Bank had to raise rates more than it and the markets expect, that would open up a new dilemma. Every increase in interest rates would add to the government’s debt interest bill. An independent Bank, sitting on £895 billion of government bonds due to QE, assuming it sticks to the programme, could be responsible for adding tens of billions a year to that interest bill.

A new paper from the National Institute of Economic and Social Research called “Quantitative tightening: Protecting monetary policy from fiscal encroachment” — by Jagjit Chadha, William Allen and Philip Turner — addresses this issue.

As it points out: “The vulnerability of the central bank’s balance sheet (and thus government finances) to lower bond prices and higher policy interest rates is therefore now greater than at any time during the QE decade.” Some suggest the Bank should stop paying the banks interest on their reserves.

The paper proposes a different solution. It is technical but it should start, the authors say, with the Treasury swapping out some of the long-dated gilts (UK government bonds) it holds as a result of QE for shorter-dated paper. This process should start now, “to protect the independence of the central bank”.

Low interest rates and QE have changed the monetary landscape. Both can be changed and there is arguably more scope for running down the vast amounts of QE the Bank has undertaken than there is for raising interest rates too aggressively. The Bank has found itself in a position that those running it in the past could never have envisaged. Getting out of it will be a tricky task.

PS

I was away last week — enjoying glorious Welsh weather that I hope was not the entirety of the summer — and so the stock of fresh jokes has run low. In the meantime, a more serious issue.

Many of us have got used to online meetings over the past 18 months, via Zoom, Teams and other platforms. Some have suggested that this will be the death knell for business travel. Such travel is not, however, all about swanning off to exotic locations for conferences.

A West Midlands specialist engineering company got in touch recently. It exports 90 per cent of its turnover but its ability to generate new export orders has been seriously curtailed by travel restrictions. Its customers need face-to-face meetings and demonstrations and have not been getting them. They have been getting them from European competitors, travel within the EU being much less restricted, and the loss of trade has been enough to threaten the very survival of a business established half a century ago.

Customers also need visits from engineers to service the equipment. I don’t know how typical this story is, but it would be interesting to know.

The clouds may be slowly lifting. The government is lifting quarantine requirements on double-jabbed arrivals from the EU and America, which will ease the burden on those returning to the UK after business trips.

The latest Office for National Statistics figures show that, in the week to July 25, flights rose by 17 per cent to their highest level since the eve of the first national lockdown.

We shall see, but it will take a long time before business travel returns to normal. Damage is being done.

david.smith@sunday-times.co.uk