Managing my financial journey
Managing my financial journey

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Managing my financial journey

3.1.2 Have borrowers never had it so good?

In the following video, Andy Haldane, chief economist of the Bank of England, talks to Martin about the trends in borrowing in the UK during the current period of low interest rates and whether these trends are of concern to the Bank.

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I want to turn now to what's happened to household borrowing over the course of the last few years.
We know that the boom in household borrowing was one of the reasons which fed into the financial crisis in the 2000s. Since the financial crisis, and until recently, household borrowing has been well pretty much at the same level that it was around 2007/2008, in fact unsecured borrowing has actually fallen slightly. Recently though household borrowing seems to have picked up again and I know that some people are thinking, including myself, are concerned about this.
Is it a problem and if so what can you do about it given that really there is very little scope to raise interest rates significantly in the near future?
So, looking backwards, I mean your diagnosis is right. You have the benefit of that glorious 20/20 hindsight again, credit did rise somewhat too rapidly in that pre-crisis period. Debts got too large. And therefore what we saw after the crisis understandably enough was both households and companies, so called took 'deleveraging', that is to say, paying down their debts to make them somewhat more manageable. And that's one of the reasons why new credit growth was so weak in the immediate aftermath of the crisis, people were paying back more debt than they were taking on new debt.
Now that process of so-called deleveraging, running down your debts, appeared to stabilise a couple of years ago among both companies and households. What we've seen since then is actually a pretty modest increase in credit growth for both companies and households actually. So you have credit growth to companies rising at no more than two or three per cent at the moment and even for households it's little more than that. Certainly for mortgage borrowing that's at very modest levels, around two per cent growth, which is very low by any historical standard. The element of credit which has shown greater perkiness hasn't been borrowing to buy houses but the more personal loan side of the equation that's growing at perhaps seven or eight per cent. Even that is actually well south of its historical averages.
So it isn't screaming credit boom at all at the moment but has it picked up? Yes.
Does it therefore bear some careful watching? Yes.
And do we now have a piece of regulatory architecture whose job it is to look at those pockets of credit? Yes we do in the form of the Financial Policy Committee and if they felt that was picking up too rapidly then they have regulatory tools at their disposal that will enable them to do something about it.
So we're not yet at the point of being remotely in a credit boom I don't think, but if we did move closer towards that we have now a body, a regulatory body with tools in its tool kit that could help head that problem off.
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Those borrowing money in recent years have benefited from the historically low rates of interest charged on debt products. Why have interest rates been so low since the end of the 2000s? To understand this, we need to explore how the ‘official’ rate of interest is set in the UK, since this provides the basis on which interest rates on financial services products are set.

As we saw in Week 2, responsibility for monetary policy was passed from the UK government to the Bank of England in 1997. This enables the Bank to set the level of the UK’s official interest rate without being subject to political influence. This matches the arrangement in the US and in the eurozone, where the official rates are set by the Federal Reserve Bank and the European Central Bank respectively.

The rate set by the Bank’s Monetary Policy Committee (MPC) – Bank Rate – is the rate at which the Bank of England will lend to the financial institutions. This, in turn, determines the level of bank ‘base rates’ – the minimum level at which the banks will normally lend money. Consequently, Bank Rate effectively sets the general level of interest rates for the economy as a whole. Bank Rate is therefore hugely influential in the determination of the rate that will be paid on savings and interest-bearing investment products.

The prime objective is for the MPC to set interest rates at a level consistent with inflation of 2 per cent per annum (p.a.). For example, if the MPC believes inflation will go above 2 per cent p.a., it might increase interest rates in order to discourage people from taking on debt – because if people spend less, it could reduce the upward pressure on prices. Conversely, if the MPC believes inflation will be much below 2 per cent p.a. it might lower interest rates (also known as ‘easing monetary policy’) – people might then borrow and spend more.

Given the weakness of the economy after the financial crisis, Bank Rate was cut to a historic low of 0.5 per cent in March 2009 to help stabilise the financial system and foster economic activity. The rate remained at this level until August 2016 when it was cut further to 0.25% to help confidence in the economy after the vote to leave the European Union (Brexit) in the June 2016 referendum.

With unemployment falling quickly after 2012 and with stronger economic activity generally, the governor of the Bank of England, Mark Carney, regularly indicated that Bank Rate was likely to rise (gradually) in the not too distant future to prevent inflationary pressures building. Eventually in November 2017 the MPC raised Bank Rate to 0.5% – the first increase for ten years.

Despite falling unemployment, the absence of material price inflation pressure and the uncertainties about the prospects for the UK economy once Brexit occurs have provided a strong argument to hold off from tightening monetary policy materially. This is continued good news for borrowers although, as Andy Haldane comments in the video, the growth in certain forms of personal borrowing – partly stimulated by the prevailing low interest rates – is a matter of concern.

Described image
Figure 3 Nominal and real interest rates and inflation in the UK, 1980–2017 (Bank of England, 2017; ONS, 2017).

Official rates of interest tend to be cyclical, rising to peaks and then falling to troughs. Since 1989, the trend in the UK has been for nominal interest rates to peak at successively lower levels. Nominal rates fell to 3.5 per cent in 2003. In 2009 they hit a record low of 0.5 per cent.

Note that real interest rates are nominal rates adjusted for the prevailing rate of price inflation. So, for example, if the nominal rate of interest is 2 per cent and price inflation is 2 per cent, the real interest rate would be 0 per cent (zero).


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