Wealth & assets

Peaked Interest?

What higher interest rates mean for the size and distribution of Britain's household wealth

Molly Broome
Molly Broome
Ian Mulheirn
Ian Mulheirn
Simon Pittaway
Simon Pittaway

Over the past four decades, the total value of wealth owned by UK households has been on a seemingly-relentless upward path: rising from around three-times GDP in the mid 1980s to almost eight-times.  The key driver of this rise in wealth has been falling interest rates and the associated increase in asset prices. But the cost of living crisis has thrown this upward march into reverse as interest have risen sharply in response to the highest inflation in 40 years.

In this report we explore the impact of both changes in households’ active saving behaviour, as well as ‘passive’ moves driven by the sudden end to ultra-low interest rates, on the composition and distribution of household wealth. In addition, we discuss how policy makers should think about how to respond to seismic changes in the level – and volatility – of interest rates.

Key findings

  • Household saving has whipsawed over the past three years. The adjusted saving ratio peaked during the pandemic at 24.4 per cent – the highest on record. Saving has declined since but remains above its pre-pandemic level.
  • Saving behaviour has direct implications for household wealth holdings, but the fluctuations in interest rates have had a more profound impact: the pandemic saw interest rates hit record lows and asset prices boom which pushed the value of wealth to a peak of 840 per cent of GDP in early 2021.
  • The cost of living crisis, coupled with the monetary policy response, has put an end to the trend of rising wealth. Our estimates suggest that the wealth-to-GDP ratio fell to around 650 per cent by early 2023. This is by far the biggest fall on record as a proportion of GDP, wiping out £2.1 trillion of household net worth in cash terms.
  • A higher-rates world and an ultra-low rates world represent starkly different societies to live in. If the rise in long-term interest rates persists, would could see household wealth settling at around 550 per cent of GDP, a level last seen in 2007. But, if downward pressure on long-term interest rates resumes, this could see wealth settling at around ten-times GDP.
  • The future path of long-term interest rates matters hugely in the context of intergenerational inequality. Higher rates of return make it significantly easier to save for retirement. Pre-pandemic, a 40-year-old with median earnings needed to save approximately 16 per cent of their gross income (just over £5,000 a year) to reach a retirement target replacement rate of two-thirds of gross earnings. However, with current rates of return, the required contribution rate for the same goal is much lower at 9 per cent (£3,000 per year).
  • A higher-rates world would also improve housing affordability, helping young, would-be homeowners. Based on current interest rates, the house-price-to-earnings ratio could fall to around 5.6 – the lowest level seen since 2000. But if ultra-low rates return, there would be further upward pressure on house prices, with our modelling suggesting that they could reach 11 times earnings.

Further reading

Ineffective Savings Accounts
·
Molly Broome
In too deep?
The impact of the cost of living crisis on household debt
·
Felicia Odamtten, Simon Pittaway
Precautionary tales
Tackling the problem of low saving among UK households
·
Molly Broome, Ian Mulheirn, Simon Pittaway
Molly Broome
Molly Broome Economist
Ian Mulheirn
Ian Mulheirn Research Associate
Simon Pittaway
Simon Pittaway Senior Economist