IN BUSINESS, as in affairs of the heart, the past is another country. Back in 2007, when the economy was last growing at a pace we thought to be natural, even everlasting, official interest rates were at 5 per cent.
Mortgage lending was booming. House prices as measured by the Nationwide were rising at an annual rate of 9.1 per cent. Business investment was rising, GDP growth was running above three per cent and unemployment was down at 5.3 per cent. Gordon Brown had pronounced “the end of boom and bust”. What could possibly go wrong?
Over the next year, almost everything did. By the start of 2009, credit was frozen, the economy plunging and interest rates were slashed to just 0.5 per cent – a crisis level suggestive of an economy set for a re-run of the Great Depression. Ghastly as it all was, few imagined that this ultra-low level of money costs would last for long. It was, surely, an emergency response to an emergency situation, unlikely to last for more than a few months at most.
But it took three years for the economy to begin a slow and hesitant recovery – the longest on peacetime record. Yet a recovery now there most certainly is. Unemployment has tumbled and numbers in work have hit an all-time record. Business confidence has rallied.
Nowhere is evidence of recovery more marked than in the housing market. After a precipitous slump which sent house building into a downward spiral, mortgage lending is booming. Approvals for house purchases hit a 70-month high of 70,758 in November, up almost a third on the level a year ago. House prices, as measured by the Nationwide, have jumped 1.4 per cent month on month and are up 8.4 per cent on last year. This is the strongest month-on-month increase in house prices since August 2009 and the highest year-on-year increase since June 2010.
There is a tendency among the cognoscenti to dismiss a housing-led upturn as the “wrong sort” of recovery. But the domestic economy is inextricably linked to the health of the housing market. The lofty view patronises the aspirations of those wishing to own their own home or improve the one they are in. It also makes light of the wider effects of a housing upturn – more houses being built, more changing hands, more renovations, upgrades and improvements, boosting demand for plumbers, joiners, electricians, kitchen fitters, painters, decorators and hard and soft furnishers alike.
The housing upturn lifts many boats – and the fortunes of hundreds of thousands of people. And in enlarging, modernising and improving the housing stock, it fulfils a positive and beneficial macro-economic benefit. Little wonder, then, that we are now seeing confident forecasts that overall growth this year could be as high as three per cent.
Yet you would glean little of this from the level of interest rates. The Bank of England’s official rate remains firmly stuck at 0.5 per cent – and with “forward guidance” from Bank governor Mark Carney of no change in rate policy for at least a year.
If the recovery continues at this sort of pace – and the latest readings from the Bank of Scotland Business Monitor suggest exactly this – is it at all rational to expect that interest rates will remain at this Depression-era level?
Yet already hands are being wrung at the prospect of a rise. I do not share the gloomy prognosis that this is a prospect to be feared and one that would bring an abrupt halt to the economic upturn.
Well before the end of 2014 there will be concern that, as the house price upturn broadens out across all parts of the UK, there is a risk of another housing bubble. Should mortgage lending continue to rise at this pace it is likely that more areas will experience overheating. For this reason alone, a rise in interest rates would be inevitable.
However, it is one thing to move off an ultra-low crisis level of interest rates, quite another to push through a barn-storming series of rises to four per cent and above within a short period of time, as some fear. But that looks unlikely. After the initial rise we may see a series of phased, small-step increases over a period of years. Indeed, the earlier the first increase, the less steep the gradient in the subsequent period.
Another concern is that over-borrowed households could not withstand a rise in interest rates. But debt levels are notably reduced from pre-crisis peaks and as a result most households should be able to withstand such a rise.
As it is, many households have been using the low interest rate era not to take out extra debt but to pay down their outstanding mortgage. This is officially described as “net housing equity injection” – in plain terms an increase in the level of personal investment that mortgage borrowers have in the value of the property. Last week, the Bank of England reported that households received a further net housing equity injection of £10.4 billion in the third quarter of last year, the 22nd successive quarterly net injection. In past years, housing equity withdrawal – using the rising value of the property to take out an extra mortgage – was the rocket fuel for a consumer spending spree. Such spending has been notably subdued in recent years. As for the amount of equity we hold in our own homes, the cumulative net equity injection since the second quarter of 2008 now totals almost £216 billion. This alone should help provide more resilience for home owners in the inevitable step-off from ultra-low rates.
Finally, should the prospect of an end in sight to 0.5 per cent rates fill us with apprehension, consider the state we would be in were such a rate to extend into the distant future. It would suggest an economy almost permanently crippled and unable to function other than on emergency life support.
On this view, a return to a more normal interest rate regime should be viewed for what it is – a clear, unambiguous sign of recovery and one which is overwhelmingly positive after the traumas inflicted by the financial crisis.