The upsides of inflation with rising GDP and mortgage rates

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This week we’re going to talk through a little bit about the upsides of inflation, and why inflation decreases costs in real terms, one of my favourite economics terms.

Before we get into that, if you’ve seen the news cycle so far into 2022, it’s been pretty crazy. We’ve got Boris Johnson having an inquiry into where he was, which takes some thinking about. Prince Andrew’s no longer Prince Andrew for reasons which I’m absolutely not going to get into. Then you’ve got Djokovic’s ongoing visa saga, which is a bit of a shambles really. I thought the UK was turning into a backward little island until Australia weighed in with their visa policy. So that’s just what the first few weeks had in store. Looks like it’s going to be a lively, lively year!

Inflation and debt

But more specifically in the mortgage world, what we’re going to talk about is inflation and debt.

It’s one of these symbiotic relationships in economic terms. The thing that triggered this thought is that GDP is now above pre-pandemic levels, what that means in the context of the very high inflation we have is in the UK right now, and then ultimately, where that will take us with interest rates.

GDP, inflation, and interest rates

The most recent available figures for GDP are for November last year which showed GDP was up by 0.9%, which is now 0.7% above when Covid started.

Construction growth

It was interesting that construction was the main growth area at 3.5% which is really relevant when you’re in the property and mortgage world. So if developers do start building property more meaningfully, that hopefully might mean that property prices won’t go too sky-high.

Developers and cladding

Another interesting point that caught my attention this week (I believe it was Michael Gove on Radio 4) is that the government is specifically targeting developers to resolve the issues around cladding. We’re not very clear exactly on how, as there are two months to sort it out, but the onus is not on the owner of the property but the developer.

GDP

Back to GDP. This is a  really interesting quote I picked up from Derrick Dunne, CEO of YOU Asset Management, he commented:

‘Economists are predicting that UK economic growth could outstrip every other G7 nation this year, and today’s data is timely reminder that investors should prepare to make the most of it with sky-high inflation and supply chain disruptions still on the agenda a resilient portfolio prepares you for the challenges is still the best solutions.’

A bit of a pitch there at the end, but this is really the point, with the economic growth we’re going to experience combined with high inflation, makes the UK a very interesting place economically. A small caveat to put on these figures, they are pre-Omicron figures so let’s see how it plays out.

So what does it mean when you have inflation and debt together?

I’ve pulled out some figures to contextualise this. As of October 21 (the latest figures I could find for the UK), national debt was £2.2 trillion, 103% of GDP.

To put this into context imagine you had, for example, 1 x your income on unsecured debt, things loans, credit cards, etc. You know how painful that feels. That is sort of where the UK is right now. I appreciate the dynamics are very different (long term debt etc.) but when once you are around that sort of area it’s extremely uncomfortable. We are one of very few countries in the Western world that has debt that high versus GDP.

 That means a number of things, but just to break it down.

Squeeze on personal and national finance

The national figure means ultimately we can’t raise interest rates too high.

The average credit card debt in the UK is £2,033 pounds with an average eye-watering interest rate of 21%. If that’s you, you’re really feeling the pinch. Also, mortgage debt is going up as well again. At the end of Q3 21 mortgage debt was at an all-time high of 1.6 trillion which is up 4.9% on the previous year. If, as we’ve said the average UK salary is £31,258, combined those things put quite a squeeze on personal and national finances.

How is that a good thing?

So you could say well how on earth is that a good thing? Well, t’s not, it’s really really bad. I think the large level of debt is akin to modern slavery. Even if you have a very high salary, if you’re trying to pay off debts or trying to service high debt then this is practically akin to modern slavery I think, in the theoretical sense at least.

You can argue it’s a good thing when GDP is on the up. As economic growth in GDP terms (Gross Domestic Product – when you add up everything that’s sold produced in the UK) increases or increases higher than inflation the effect is to push debt down in real terms. Just last month wage inflation was up 4.9% and inflation, as measured by CPI, was up by 5.1% last year. What this is doing is pushing down the debt in real terms.

To contextualise what this means, and to place it inside the property arena, inflation indeed does decrease debt over time.

Inflation and decrease of debt over time example

If you bought a property in 1971 the average house price was, wait for it, £5,623. Interestingly the average salary was £1,204. So that means the average property was 4.6 times the average salary.

Roll that forward to today, the 2021 average house price finished at an average of £268,349. The average wage is £31,258 and it is 8.6 times the average house value.

House prices have far exceeded inflation over time and are actually relatively more expensive.

If you borrowed £4,000 in 1971 with an interest-only loan and you still had the mortgage today (I’ve picked the 40-year term specifically because if you’re a first-time buyer and you push out for the maximum term available some banks are doing a 40-year term) the £4,000 in 1971 represented 72% of the property value, working on roughly £5,600 for the average property value. But if you still had that £4,000 loan today that represents now just 1. 5% of that same property’s value.

 That is how inflation decreases debt in real terms.

I am sort of thinking that’s what the UK government is doing. They’re doing a lot of borrowing over very long periods and they’re hoping that CPI inflation and all other forms of inflation that we experience will push that debt down until GDP goes up to a point where it’s a lot more manageable and you get to pay it off. It’s a hockey stick sort of scenario that they’re going for there. There is a lot of talk around Modern Money Theory (MMT) which is worth looking at because I think a lot of that is at play.

Put that all together and we will see a sort of an environment, which I can’t think of certainly in the last few hundred years, where we’ve been a situation with huge levels of national debt and rising inflation and rising GDP. I don’t remember seeing that but I’m not a historian or an economist I’m very happy to be corrected.

Keeping interest rates low

This means specifically now and going forward that this situation is going to keep interest rates very low for a very long time. Just to give you an idea 10-year SWAP rates, which is what banks predict money will be, is at 1.1% in 10 years’ time. Now the Bank of England base rate is only 0.25% so that tells me two things: rates aren’t going to go very far, they’re not going very fast and they’re going to stay low. It also means right now is probably the cheapest time you were ever going to borrow money in your lifetime. That is all things being equal as we know a lot of unforeseen things happen but that’s certainly where we think things will be over the coming years.

Market rates this week

 Let’s look at the market rates this week, interesting… all sort of pegged back a little bit. I think there was a bit of a knee jerk reaction after the Bank of England raised interest rates in December

That trend is going to turn quickly but for the reasons I’ve just explored, probably why they’re not so quickly, so money market rates are down a little bit. Five-year money is at 1.142, two-year money is at 1.075 and three-month Libor is at 0.511 which indicated the Bank of England will probably raise interest rates at some point in the next three months. That’s what money markets are hedging on.

Mortgage rates this week

So how does that translate directly into mortgage rates? Because that’s the money market rates that banks apply a margin above.

The best variable market right now is 0.99%. The best 2 year fixed is now 1.11% and the best five-year fixed rate is 1.46%.  

Interesting to note that those fixed rates are more expensive than last week alone which is why I’m d banging the drum now about locking in for a long term, might be a really good idea.

Now the interest rate you will be offered is dependent upon your personal circumstances and level of deposit. The figures mentioned above are really based on if you’ve got a 40% deposit or more in a really straightforward situation. So if your situation isn’t straightforward or you have less of a deposit, you may well be paying a higher interest rate than those above.

Source: Twenty7Tec January 2022

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