Banks hint at more rate rises

When the message comes from the top, you’d better start to believe it. Governor of the Bank of England Mervyn King has warned families to prepare themselves for more interest rate rises in the coming months. He said that there were an alarming number of economic indicators that are still ‘elevated’ – and that included the rising cost of property.

His indications were that the Bank may have to raise interest rates again – from the current level of 5.5%, to 5.75%, or even higher. The aim is still to dampen the house price boom. The rate of 5.5% represents a six-year high and further rate rises are going to heap misery onto mortgage borrowers already struggling with the increased mortgage payments they have already suffered.

Mr King also warned families and first-time buyers against borrowing more than they can sensibly afford, emphasising the need to be more cautious with borrowing in times of rising interest rates.

It is unusual for a Governor of the Bank to be so blunt in his statements. In the past Mr King has been rather more reticent about the future direction of interest rates, and comments are usually draped in technical jargon used in the Bank’s Monetary Policy Committee’s (MPC) reports. This is the committee that actually sets rates, and its next announcement is on Thursday 5 July.

The Governor expressed his concerns that many people will reach the tipping point with another rate rise, due to their high levels of debt. Nevertheless, the Bank could not take the risk of ignoring the overheating economy.

He stated that if the indicators remained elevated then the MPC may need to take further action.

It all makes for grim listening for families who have suffered from recent rate rises, and whose budgets are stretched by borrowing costs at their highest level for six years. Mortgage interest payments already represent the highest portion of earnings since 1992 when interest rates were at 10%, and the country was in recession.

Nevertheless the economy has continued to heat up, and the Bank may push up rates again. Mr King said that financial market traders already expect interest rates to go up to 6% by the end of the year, and indeed industry-watchers have been making that forecast ever since the rise in May.

Despite the rise in May, and the subsequent very speedy rise in mortgage rates by providers, it is said that many mortgage consumers have yet to feel the consequences of it, and indeed the previous three rate rises. This is because many took out two or three year fixed rates two and three years ago, and they will soon be coming to the point where they need to remortgage, and they will feel the full force of the 1% rate rise that has accrued since last August. While they remain immune from the effects, they are continuing to build up debt, but those effects may be just around the corner, and many families will not be able to cope with their new adverse financial circumstances. Mr King urged families to be far more restrained. He suggested that it was unwise to borrow amounts that are only affordable if repayments stay at current or initial levels.

As most mortgage rates have increased at the Standard Variable Rate by at least the same as the base rate (1%), annual interest payments on an example mortgage of £150,000 will have risen by £1,150 over the past year. A further quarter point rise to 5.75% would add nearly £300 to the annual bill.

The Bank has a number of worries about the economy, and especially effects on inflation, such as rising prices from factories and High Street retailers to their customers, and the growth in bank lending increasing the amount of money moving around in the economy – at its highest level since 1990. These add to fears of inflation increasing again.

May’s figures for inflation were down to 2.5%, as was expected, from 2.8% in April. Reductions in gas and electricity prices have helped reduce inflation, as have lower food prices, especially for meat and vegetables. Nevertheless, food prices are still rising at twice the inflation rate. The core inflation rate, excluding food, alcohol, tobacco and energy was up to 1.9%, from 1.8% in April. This shows an underlying upward trend in inflation. In the UK, expectations of higher inflation, higher house prices and higher mortgage rates have led people to expect a rise in their wages.

House prices showed signs of a slowdown in May, but over the last year they have shown an alarming rise. The annual house price was 11.3% to April.

The World Gross Domestic Product is rising at its fastest rate since the late 1960s, and Mr King said this was propping up stronger economic expansion.

The Government’s target for inflation is 2%, but for 13 months inflation has been above target.

It looks like there are difficult times ahead.