Why the British economy is currently one of the most vulnerable

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There is an economic idiosyncrasy in the United Kingdom that makes it “one of the most vulnerable countries in the world at the moment”, according to the investment strategist.

Mike Harris, founder of Cribstone Strategic Macro, argues that the big problem for Britain is that its mortgage market is “largely short-term”. While in the US and other parts of Europe, citizens prefer long-term mortgages, many Britons are opting for short-term loans of less than five years. Tracking mortgages that vary with the base rate of the Bank of England are also popular.

Harris told CNBC on Friday that this was a problem because raising the rate would immediately cause losses in household income, while it would not actually address the issue of inflation. He explained that the United Kingdom is a country that “imports inflation”, so the effect of the increase in interest rates by the Bank of England was not just a rebalance of supply and demand that would slowly curb the growth of consumer prices.

“Here. We are not really dealing with a clean situation in which we are trying to slow down the economy, ultimately trying to rebalance expectations, and the UK is a country that imports inflation … So we are not effectively in a position where we are free to focus effectively on supply and demand “, He said.

He added: “We are stuck in a situation where global inflation is driving our inflation at this stage, we need to hit the consumer and instead of just reducing the propensity to spend in the future, we are actually taking extra money from household income, which is not happening in the US.”

The Bank of England raised interest rates by a quarter of a percentage point on Thursday, raising its base interest rate to 1%. These are the highest interest rates since 2009 and this is the fourth increase in BOE in a row. The central bank also predicts that inflation will reach 10 percent this year, with rising food and energy prices exacerbated by an unprovoked Russian attack on Ukraine.

Harris said that he twice asked the Bank of England for information on how many loans in the country were fixed for a two-year period and how much was set for five years, but he said that he was told that the central bank did not keep that information.

Harris argued that “it is absolutely insane that the central bank does not appreciate the economic performance associated with any rate increase.” He explained that consumer behavior is unlikely to change much in five years, but it will happen over two years.

UK ‘faced with music’

According to the UK Finance Association, 1.5 million fixed-rate mortgages expire in 2022, and another 1.5 million are expected to do so next year.

In data released Friday, investment platform Hargreaves Lansdown calculated that someone who transferred a mortgage at the end of a two-year fixed-term contract could, after the last interest rate hike, increase their monthly payment by £ 61. If the base rate reaches 1.5%, Hargreaves Lansdown has worked out that it could add £ 134 to their monthly mortgage repayments. According to a survey of 2,000 adults in the UK, conducted on behalf of the platform in April, more than a third of people would find it difficult to afford these additional costs.

Harris said that because of the current rate increase, “we are in an environment where we are likely to destroy more demand than we should have because the Bank of England and [former governor] Mark Carney didn’t do his job properly. ”

He said this dynamic is similar to that with the Federal Reserve in 2007, just before the global financial crisis began, because they “allowed people to take out mortgages when they knew they couldn’t repay them if house prices fell because they were refinanced so there is inherent unsustainability. “

Harris added that the United Kingdom is now at a stage where it is “facing music”.

“I would say the UK is currently one of the most vulnerable countries in the world because of that dynamic and the fact that central bank governors have done nothing about it, they might still have time,” he said, arguing that if policymakers now had the means to prolonging this debt, they should do so “actively”.

A Bank of England spokesman declined to comment, but CNBC pointed to recent statements by Governor Andrew Bailey and Chief Economist Huw Pill.

In the past, two-year mortgages were popular because they were usually cheaper due to shorter loan periods. However, UK Finance states that the popularity of five-year contracts grew from 50% of fixed-term contracts in 2021 with that duration, while 45% was on two-year contracts.

Data from the Bank of England last week showed that the “effective” interest rate – actual interest paid – on new mortgages rose 14 basis points to 1.73% in March – the biggest increase since at least 2016, according to Bloomberg.

Cost of living squeeze

Speaking Friday on CNBC’s “Street Signs Europe” show, Bank of England chief economist Huw Pill also noted that the rise in inflation was driven by external shocks.

He said it was “embarrassing” for central bank members to predict an inflation rate of 10 percent, well above the Bank’s long-term goal of 2 percent.

“Of course this discomfort must be viewed in the context of the real impact of cost-of-living on households and businesses here in the UK, it is more painful for them than the discomfort from a policy maker’s point of view,” Pill added.

He explained that the Bank of England is trying to use monetary policy to ensure that these drivers of inflation do not lead to consistently higher prices and create a stagflationary environment like that of the 1970s. But he said the central bank wants to get inflation back on target without introducing “unnecessary volatility into the economy”.

Bank of England Governor Andrew Bailey told CNBC’s Geoff Cutmore on Thursday that the UK was experiencing an “unprecedentedly large shock to the real income in this country coming from abroad”, in terms of trade issues.

Bailey also defended a more cautious approach by the central bank to raising interest rates, with three disagreements with a member of its MPC arguing that the BOE should be more aggressive with its increase.

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