Squeezed incomes & interest rates

Today’s national accounts numbers show that households’ real disposable incomes have fallen by 3.5% since 2009Q2. This is the biggest squeeze on real living standards since 1977.
This, I suspect, has some under-appreciated implications for interest rates.
The most obvious is simply that the Bank will be loath to raise rates for fear of intensifying the squeeze on incomes and hence consumer spending. Each percentage point rise in interest rates would raise the aggregate net interest payments of households by about £2.7bn over a year - equivalent to a 0.3% cut in disposable income.
There are, though, a couple of less obvious but also important considerations. One is that the squeeze on incomes has made it harder to people to increase savings or pay down debt; the savings ratio actually fell in Q1 and overall borrowing has increased recently. This suggests that insofar as some households have been overly indebted, this problem is continuing. A rise in interest rates could, then, tip them into big trouble.
Of course, the average household is not in massive debt: aggregate household debt, at £1.45 trillion, is equivalent to less than 18 months disposable income, which is manageable; few of you would find a mortgage of 1.5 times your net salary onerous. But debt is not evenly distributed. There’s a tail of households who are in big trouble. The Bank of England’s latest Financial Stability Review (pdf) warned that an increasing proportion of household debt is held by “vulnerable” borrowers - those with low housing equity or having difficulty making payments.
Worse still, it said, exposure to these borrowers is “likely to be concentrated in a few banks”. And, it added, “these vulnerable households’ incomes could be affected by fiscal consolidation.”
In this sense, an interest rate rise exacerbates a particular tail risk. When allied to the squeeze on some debtors’ incomes, and to the danger that public sector job losses could tip some of the indebted into default, the result could be a large increase in bad debts and defaults.  Not only would this give another kick to consumer spending, the resulting banking losses could lead to a reduced availability of credit generally.
Note that in this context, the possibility that public sector job losses might be offset by private sector job creation is not necessarily a relief. If a highly indebted person loses his job whilst a less geared one finds work, the result will be an increase in financial distress.
Through these routes, the squeeze on real incomes reduces the prospects of a rise in Bank rate.
Which brings me to a curious political point. A great many Tory supporters - older, richer folk - would benefit greatly from higher interest rates. However, fiscal restraint - which is contributing to the fall in real incomes - makes such a rise less likely. In this sense, many Tories - millions I suspect - support policies which are not in their direct economic interest.

Comments

[Mark Wadsworth]

"Each percentage point rise in interest rates would raise the aggregate net interest payments of households by about £2.7bn over a year"

Not really - net interest income of banks has gone up by £20 bn a year since credit crunch, as they used this as an excuse to drop deposit rates to nearly nil and drop mortgage rates by about one per cent.

And interest rate increases increase income of savers and reduce income of borrowers. If the government hiked interest rates, this would reduce the margin earned by banks and therefore INCREASE net disposable income of UK households and businesses.

[Grumpy Old Man]

Many Tories - millions I suspect - have children and grand-children who are struggling to make a life in post-Brownian Britain and however unwillingly support the policies that will give their descendants a chance in life, even though their direct economic interests are adversely affected.

[B Gudgeon]

‘...many Tories - millions I suspect - support policies which are not in their direct economic interest.’ Many Tories, I suggest, accept this burden (through gritted teeth) as necessary for the National interest.

[Allan Jones]

‘...many Tories - millions I suspect - support policies which are not in their direct economic interest.’

Maybe these Tories assume that, even if fiscal policy were looser, monetary policy would not be tighter on the grounds that they observe that the Bank/government appears to have abandoned its inflation target (at least the published one).

[Keith]

"In this sense, many Tories - millions I suspect - support policies which are not in their direct economic interest." Well yes but so what? That is nothing new. Many people are Tories as they are too dim and ignorant about economics and other matters to know any different so good enough for them; it is just unfortunate that the rest of us suffer as well! Save your pity for us!

One reason for the vulnerability to interest rate spikes in the uk is our housing policy of neglecting council housing and bribing and bullying more and more households into owner occupation via large mortgages and crap private renting. Bad for disposable income and bad for demand management. But Mr.Cameron seems to want to confiscate old peoples savings and houses to finance social care. So the tory voters will soon get another kick in the teeth from "call me dave." If the bulk of tory voters really think their long term interests are served by the tory party they need to be on strong drugs for their delusional thinking.

[Ralph Musgrave]

The point made in the above article stems from an absurdity, which is more serious in the U.S. than in the U.K.: handing out stimulus money to Wall Street rather than Main Street.

If it becomes necessary to raise interest rates to deal with inflation, Main Street is then in even deeper sh*t. But it wouldn’t be in the latter situation if stimulus had been directed to where it was needed. I.e. had stimulus been channelled in the right direction, and interest rates were increased, it would have been a few banks going bust rather than households going bust. My reaction would be to open a bottle of champagne.

[Mark Wadsworth]

Keith: "But Mr.Cameron seems to want to confiscate old peoples savings and houses to finance social care."

Why is making people pay for themselves 'confiscating'? Is it better to confiscate money from non-old people (i.e. by taxing incomes) to pay for it? And if so, why?

[Grace]

Really eye opening post.

[Neil]

"Many Tories - millions I suspect - have children and grand-children"

Nope, sorry, doesn't work: I personally know several Tories who are supporting policies that are directly to their own children's detriment. They're throwing baby out with the bathwater.

[Blissex]

«Which brings me to a curious political point. A great many Tory supporters - older, richer folk - would benefit greatly from higher interest rates.»

No, this is so wrong that it is almost absurd. What these guys want is low tax or tax free capital gains.

This has been the goal of conservatives in several countries in the past 2-3 decades.

«However, fiscal restraint - which is contributing to the fall in real incomes - makes such a rise less likely. In this sense, many Tories - millions I suspect - support policies which are not in their direct economic interest.»

Low interest rates directly support and enhance asset prices.

Then main conservative policy in the past 2-3 decades in many first world countries has been debt-fueled asset price bubbles, so richer people can liquidate their investments at the best possible prices to reinvest in emerging markets.

The middle classes have been enthusiastically supporting pump-and-dump policies based on low interest rate fueled asset bubbles, because they delude themselves that they will be among the pump-and-dump beneficiaries.

It is just all about older richer people with property wanting to retire in splendid luxury thanks to the ever rising house and share prices redistributing income from the those who have less property to those who have more.

[Blissex]

«"But Mr.Cameron seems to want to confiscate old peoples savings and houses to finance social care."

Why is making people pay for themselves 'confiscating'?»

Even more appropriately, the real debate about getting old people's property "confiscated" to pay for their care is not in any way about the old people: because they cannot take that property with them when they die.

The whole debate is about middle aged and younger people who want to become effortlessly rich by inhering a lot of tax free property from their elders, who should not waste it on their care.

So the care of all elderly should be socialized to leave their estates untouched. The logic is that it is much fairer to cut the unemployment, disability and other welfare benefits going to lazy greedy scroungers than to "confiscate" the estate that so deserves to turn into instant wealth for "aspirational" middle class voters.