The age of cheap money is over

As interest rates surge, Britain needs a new economic model not based on a toxic housing market.

Illustration by André Carrilho

It seemed as if the age of cheap money would never end. The Bank of England’s base interest rate was cut to 0.5 per cent in the aftermath of the 2008 financial crisis and it would remain below 1 per cent for the next 13 years. A succession of economic shocks – the 2016 Brexit vote, the Covid-19 pandemic – led Threadneedle Street to adopt ever-looser monetary policy.

But the return of “the beast of inflation” – the phrase used by the Bank’s former chief economist Andy Haldane in a prescient essay published in the New Statesman in 2021 – has forced a reckoning. As this issue went to press, the Bank of England was expected to raise its base rate to at least 4.75 per cent – a level not seen since October 2008, just after the crash. A typical two-year mortgage now has an interest rate of more than 6 per cent. As a consequence, 800,000 households due to remortgage will pay an average of £2,900 a year more.

The new era of monetary tightening will have dramatic economic and political consequences. In their quest to return inflation to 2 per cent, both the Bank of England and the government appear prepared to accept a potential recession. The former has announced an external review of its forecasting model after being humiliated by the inflation it promised would be temporary.

Questions should also be asked about the Bank’s decision to expand quantitative easing (QE) – digitally created money used to buy government bonds – by £450bn in 2020-21. This, as Mr Haldane foresaw, inevitably had inflationary consequences (he voted in June 2021 to reduce the eventual stock of QE by £50bn).

The Bank is racing to catch the beast of inflation but it is losing credibility by the day. As mortgage rates surge, there are calls for the state to intervene, as it did to cap energy bills last year. The Liberal Democrats, bidding for middle-class voters in the Conservative Blue Wall, have demanded a £3bn “mortgage protection fund” to protect families falling into arrears.

But such a policy would have predictably inflationary consequences. Rather than intervening yet again to subsidise the housing market, the state needs to end its addiction to doing so.

The pain faced by borrowers is a consequence of successive housing booms: while house prices are 65 times higher now than in 1970, average wages are only 35 times higher. Over the decade that followed the 2008 financial crisis, ultra-low interest rates sustained a form of zombie capitalism and created an illusion of prosperity. But this bargain is unravelling. The only long-term solution is for the UK to evolve an economic model no longer based on hyper-financialisation, one in which productive investment trumps rent extraction.

The Conservatives, the party that championed a “property-owning democracy”, now face a political crisis as well as an economic one. There are just three Tory seats – Chelsea and Fulham, Kensington and Cities of London and Westminster – where home ownership is below 50 per cent. The rise of new-build suburbs and a decade of cheap credit was an underrated factor in the Conservatives’ march across the Red Wall in 2019.

But Labour must face its own reckoning. The end of cheap money has prompted the party to delay its pledge to spend £28bn a year on green investment, and to rule out universal childcare. Shadow cabinet ministers face an increasingly Hobbesian struggle as they bid for scarcer financial resources.

Yet Labour has choices available to it. The party has to date focused on uncontentious tax rises, such as abolishing the non-domiciled tax status and levying VAT on private-school fees. But it could raise far more by taxing wealth and unearned income such as capital gains.

The problem is not, as both Labour and Conservative politicians sometimes suggest, that “there is no money left”. Rather, it is concentrated at the top and increasingly absent at the bottom.

A world of higher interest rates will force politicians to confront choices they avoided during a decade of delusion. No government can credibly rely on growth or borrowing to fund its priorities. Who then will pay as the age of cheap money ends?

[See also: Austerity on trial]