Macroeconomic policy Crunching the numbers on today’s rate rise 2 November 2017 by Matthew Whittaker Matthew Whittaker Interest rates are up. It may be a very modest increase but, for any number of reasons, the news is big. Ten years on from the last rise, today’s 0.25 percentage point increase in the Bank’s base rate (taking it back to the 0.5 per cent it sat at between March 2009 and August 2016) has sparked much debate – both in terms of what it says about the Bank’s assessment of the UK’s economic prospects and in terms of its impact on the country. The rate rise can be expected to work through our economy in a number of ways, impacting directly on incomes and costs as well as indirectly on behaviours. In this note, we take advantage of the detailed micro data provided by the Bank of England’s NMG Survey to consider in isolation what the impact via mortgage-rates might look like. This is a necessarily simplified approach and, while the NMG sample size is healthy (at around 6,000), all figures needed to be treated with the usual caution attached to using survey data (especially as we drill down to sub-groups). Nevertheless, such an exercise can give us some sense of just where the impact is most likely to be felt. As Torsten discussed yesterday, looking solely at the mortgage cost-related effect of the rate rise, there’s good reason to suppose that this initial move won’t be as dramatic as some news headlines have been claiming. Certainly we should expect the overnight effect to be different from the 0.25 per cent increase that was introduced in July 2007 (when the base rate was lifted to 5.75 per cent). Aside from the (very important) reasons of differing macroeconomic conditions, that’s due to three things: fewer people own property; fewer owners still have mortgages; and fewer mortgage holders have variable rate products. Taken together, these factors mean that just 11 per cent of British households have a variable rate mortgage today – down from 19 per cent a decade ago. It’s also worth noting that mortgage providers might not necessarily pass the 0.25 percentage point increase on in full. As the chart below shows, spreads over the base rate have increased significantly since the credit crunch, implying that providers might have some room to absorb some of the rate increase themselves – for reasons of competition and market share. For now though, let’s assume they do. It means we’re talking about a potential 0.25 per cent increase in mortgage interest rates that effects just one-in-ten households in the very near-term. That feels modest, but clearly some groups will be more affected than others. Let’s use eight charts to consider who looks most likely to face an increase in costs in the near-term and over time. Mid-aged and higher income households are more likely to hold variable rate mortgages The next chart sets out the proportion of households within different groups who hold any form of mortgage and – most importantly for considering the immediate effect – the proportion who hold variable rate products. As we’d expect, mortgages are more common among those aged 25-54. But the holding of variable rate products tends to grow with age. In part, this is likely to reflect the fact that older mortgagors are likely to have smaller balances and higher incomes and therefore be more comfortable with holding a moving (and cheaper) rate. That’s backed up by the fact that the average mortgage debt held on a variable rate product is substantially lower (at £70,000) than the average held on a fixed deal (£96,000). The prevalence of variable rate mortgages also increases with income, with 17 per cent of the richest fifth of the population holding such a product. In contrast, just 5 per cent of the poorest fifth of households do so. Looking across the country, there appears to be quite sizeable differentiation – likely reflecting economics and demographics. Just 8 per cent of households in the South West of England have variable rate mortgages for example, compared with 14 per cent in the East Midlands. 2. In cash terms, younger households who hold variable rate mortgages are likely to face the biggest immediate increase in repayments Taking those households identified above as holding a variable rate mortgage, we can consider what effect an immediate 0.25 percentage point increase in their mortgage costs would mean. To do so, we use the specific details (interest rate, term and current repayment) of the existing deals set out in the NMG microdata. As the chart shows, looking across all households with a variable rate mortgage the increase implies an increase in monthly repayments of just £6.40. That’s equivalent to 1.3 per cent of the existing average repayment in the group (£487). Looking across the age profile, we see that the cash impact is highest among those aged 25-34 (£9.80). In proportional terms, it is highest (2.6 per cent) for those few households aged 18-24 who hold variable rate products. 3. The initial increase will have most effect in the middle of the income distribution The next chart compares the overnight effect of a 0.25 percentage point increase on variable rate mortgage holders in the different household income quintiles. Unsurprisingly, the cash effect grows with income – reflecting both the higher propensity of variable rate mortgages in this group and the larger balances they hold. Among the richest fifth of the population, the average effect on variable rate mortgage holders is estimated to amount to £9.10 per month. Yet in proportional terms, the effect is largest in the middle of the income distribution. Within the third quintile (spanning the 40th to the 60th percentiles of the distribution), increased repayments are likely to represent 2 per cent of existing costs for those affected by the overnight change. 4. The initial change will have the biggest cash impact in London The next chart shows that the average effect of a 0.25 percentage point increase in costs would be greatest among variable rate mortgage holders in London. Here the cost impact would amount to £9.40. This is likely to reflect a number of factors – including the income and age profile of buyers in the capital, and of course higher house prices. In proportional terms however, London doesn’t come out on top. Instead, the South West records an average effect of 2.5 per cent and variable rate mortgage holders in East Anglia face an average impact of 2.3 per cent. The figure in Scotland (1.9 per cent) also tops the London one (1.6 per cent). 5. Over time, more mortgage holders will be affected by rising rates Of course, those mortgagors currently enjoying the security of fixed rate deals will not be cushioned indefinitely. The next chart describes the potential speed at which today’s rise (and any subsequent ones) will move from impacting the one-in-ten households with a variable rate mortgage to affecting the one-in-four with any form of mortgage. The proportion of households affected is set to grow from 11 per cent today to 12 per cent within a year, 17 per cent within two years and 21 per cent within three years. 6. The effect of rate rises will likely grow as more people are affected and as the base rate increases further The implication of the above is that more people will be affected over time. We might also expect rates to rise between now and the point at which many mortgagors need to re-mortgage. By way of illustration then, we can consider what effect a 1 percentage point increase in mortgage costs (in line with market expectations) would have across the same groups discussed above. This time we consider the average across all mortgage holders rather than just those with variable rate deals. The chart below shows that such a scenario would raise monthly repayments across all mortgagors (from today’s £544) by an average of £31.50, or 6.1 per cent. That’s a much more meaningful increase than the ones set out above and highlights just how significant the effect of even modest rises in interest rates might prove. The chart shows that it is again younger households who would face the biggest average increases in repayments in both cash terms (£43.60 among 25-34 year olds) and proportional (8 per cent among 18-24 year olds). 7. Under a 1 percentage point increase in costs, average repayments would rise by nearly £50 among mortgagors in the top 20 per cent of the income distribution The pattern of impacts across the income distribution is similar to the one described above in this new scenario, but the scale of the effect is clearly much bigger. In cash terms, mortgagor households in the richest fifth of the country would face average increases in their monthly repayments of £47.60. But it is again those mortgagors in the middle of the income distribution who would face the biggest proportional effect (7.9 per cent). 8. A 1 percentage point increase in mortgage costs would increase average repayments by more than twice as much in London as in the East Midlands or North East The final chart shows the effect of a 1 percentage point increase across all mortgage holders by region and nation. As before, households in London experience the biggest cash effect, with a £46.80 increase in monthly repayments. But the proportional effects are again biggest in East Anglia (8.7 per cent), the South West (8.6 per cent) and Scotland (8 per cent). The overall effect of the rate rise will be more complicated than set out here Of course, the Bank of England doesn’t raise interest rates just to change mortgage costs. Today’s rise, and any subsequent ones in this new tightening cycle, will also affect consumer credit and savings rates. And there will be wider macroeconomic and attitudinal impacts. But for many people, it is the change in monthly mortgage costs that will be the most visible change. The analysis above suggests that today’s first step will have only a modest impact – and on just one-in-ten households. But the level of secured debt still held in the UK means that the scale of impact is likely to rise quite rapidly over time. Given the challenges already facing many households as a result of the return of the wage squeeze and growing cuts to working-age welfare, any further changes in the base rate will continue to be big news in the months and years to come.