Wrong Tool for the Wrong Job

Why raising interest rates to beat inflation will not work and will cripple our economy.

By Paul Oberschneider, CEO of Hilltop Credit Partners

If there was a better recipe for disaster, I can’t think of one. Raising the cost of money to curb inflation that is being driven by supply shock/cost push inflation triggers while consumers and homeowners struggle.

The Resolution Foundation think-tank suggests that the UK has the worst inflation level of any other peer country and the Bank of England will need to continue to raise rates as it’s done this week.?A massively destructive missile in an already fragile economy.

But the tried-and-true recipe of hiking borrowing rates only slows down consumption in an overheated market environment; picture buying that extra flat-screen TV, new car sales, and a retail sales boom. Not exactly the fiscal picture we are in today. The public seems to agree; with a new survey showing that public confidence in central banks’ ability to curb inflation is at an all-time low.

But what is more like a chapter out of Alice in Wonderland, is the overarching fact that there’s scant little talk on the real causes of our inflation; aside from Covid, the Four Horsemen of the Apocalypse and no real political agenda that could explain and help solve our supply shock inflation namely;

1.????Lack of housing supply caused by a broken planning system (creating housing inflation)

2.????Out of date mortgage products with no protection for homeowners from short term rate adjustments.

3.????Brexit and cutting off our largest trading partner and cutting down immigration creating a cumulative buildup of wage inflation

4.????The War in Ukraine

Our Prime Minister said this week his number one priority was to tackle high inflation. So why are we not hearing more about the things that can be sensibly done to help rather than put a hole in people’s pockets at a time when UK real wages are the same as in 2005.?

Let’s start with the planning system. When you have a housing market that has not delivered the amount of needed housing in the market for the last 20 years, you get a market in which supply falls well short of demand. It’s that simple. Nothing too complicated for our government to get their heads around. Yes, we like the lush leafy green countryside which defines the British dream, but not using this countryside sensibly is only benefited by a handful of country landowners, not the general populist. Decentralising planning and leaving it into the hands of local councils who have no incentive to have a housing scheme being built next to their one-cow garden will not solve the problem.

Secondly, there is of course short-term mortgages which unlike most other countries around the world, place short term interest risk on the borrower. It’s a well-known fact that most advanced mortgage markets provide borrowers with 25-30 year fixed rate mortgages. That way regardless of short-term fluctuations in the markets, borrowers are protected. The US does this best with government agencies Fannie Mae & Freddie Mac two organisations created by Congress to provide liquidity, stability and affordability to the mortgage market. The UK has no such governmental boy designed to protect homeowners.

Brexit is the big one. We were all lied to. I don’t think anyone had a clue what they were proposing, and the result is Britain isolated from its largest trading partner Europe. Construction costs rise when you remove the Polish, Lithuanian and Italian builders and products, and hospitality and catering staff as well. Simple again to comprehend. Projects get delayed, service goes down the toilet and costs rise again and again. A more sensible approach would be to revisit the entire Brexit agenda and do a big Mea Culpa and reverse a bad decision.

The War in Ukraine. This is probably one of the more complex political and humanitarian issues and sadly Europe and the UK’s food and energy problems derived from this unfortunate state of affairs.?I really have no comment on this one other that as a nation almost entirely dependant on energy sourced sourced through imports, when supply chains get disrupted you get higher costs. Add to that our complete daily to sensibly explore fracking which would make the UK far more self sufficient.

So what can we do?

First of all, the BOE must take a hard look at what tools they are using and come to the realisation that current inflation-fighting tools will not work in this environment. That doing so will cripple the economy which is already on shaky grounds and will hurt people for a long time to come. On top of that, there are huge social risks we are heading for if this continues. Yes, use rates to slow down growth, but you do not raise the cost of money when growth is at zero and inflation is being caused by things outside of consumption control. This is not about slowing down the tills.

Secondly, introduce mortgage products backed by Government owned agencies that fix rates for the long term. That way when the BOE wants to use rates to combat inflationary consumption, it does so without hurting homeowners. Right now homeowners are totally exposed to short term adjustments.

Third, investment in fixing the planning system needs to take immediate effect. If not housing will never be affordable, and supply will stay limited. And thirdly long term fixed options in the mortgage market must be introduced and supported by governmental agencies.??

So yes I feel there is plenty to do.

Start with adding more housing supply in the market that is provided through better and quicker planning, and add longer-term fixed rate mortgages backed by an agency that gives liquidity assurance to banks then BOE would be able to tackle inflation with it’s current tools by targeting the short term problems like a heated economy. Which by the way this is not. And finally let's get a government who can fix the Brexit problem which is really one of the main drivers of what we are facing.