MNI INTERVIEW: BOE Faces Deeper Rate Cuts On UK Savings Impact

The Bank of England faces making deeper interest rate cuts because it confronts a reversal in the boost to savings from positive net interest income flows that has hampered the tightening cycle started in late 2021, Simon Pittaway, senior economist at the Resolution Foundation and, formerly, the BOE, told MNI.

The predominance of fixed-rate mortgages, contributing to relatively robust household finances, has resulted in positive net interest income flows to households which have weighed against the policy tightening, Pittaway points out.

While this has meant putting rates up more than would otherwise have been the case, Pittaway adds that as rate cutting gets underway, the effect will reverse, impeding the stimulatory effectiveness of policy easing and requiring deeper rate-cutting.

EFFECT PEAKED

The impact of higher rates only slowly fed through during the tightening cycle due to the fixed-term mortgages, while the uplift to savings rates was swift and by Q4 2023 the boost to household net interest income was around GBP20 billion annually, Pittaway said, partly offsetting the Bank's tightening. But the effect now seems to have peaked and is set to reverse, offsetting the impact of easing, he said.

"Once you start cutting rates for various reasons that's going to boost spending, but this is going to be working against you just as it was on the way up," Pittaway explained. "What we have is one side of the balance sheet is very responsive. But on the other side rates are predominantly fixed. So when the policy rate rises it creates a wedge that takes a while to unwind. That wedge has boosted interest income so far this cycle, but now we are going to see it unwind just as the Bank turns to cutting rates. All else equal, this would lead to you needing more stimulus to get the desired outcome."

The net interest income effect typically works in concert with tightening or easing but it has been having the opposite effect in the UK, according to Resolution Foundation research.

Pittaway cites two reasons behind what he describes as an “unusual” BOE hiking cycle; fixed-rate mortgages and the excess Covid-era savings.

"The rise of the fixed-rate mortgage that started in 2010. By the end of the decade about nine in every ten pounds of mortgage lending in the UK was at a fixed rate compared to about four pounds in every ten before the financial crisis," Pittaway said.

At the end of 2023 about two in every five households that had a mortgage in December 2021 were still on the same interest rate and around 1.5 million households are set to see their mortgages roll off this year, limiting the rise in debt interest payment while savings income rose more rapidly.

"That's big in the macro context. It's also big for individual households. That GBP20 billion net interest boost was worth about GBP700 per household, although that's an average figure for the sector as a whole and there is huge variation." Pittaway said.

POLICY CONUNDRUM

"One of the things to take away from this is this just how difficult it is doing monetary policy in the current economic environment,” he continued, noting the underlying shift in the nature of the broader economy since the global financial crisis, which “massively impacts your monetary policy transmission mechanism”.

In the UK, households rebuilt balance sheets as a result of the financial crisis, building up savings when Covid restrictions squeezed spending. But Pittaway observes very different dynamics at work in other places, most notably in the U.S. (see MNI INTERVIEW:Tough For BOE To Agree Scenarios-NIESR's Millard)

American households "are burning through their pandemic savings and they're taking on more debt. And so that's eaten into their net interest income position….they are not experiencing this interest income boost in anything like the way that we're seeing in the UK.”

“What we are seeing in the UK is historically unprecedented and also internationally unusual," Pittaway concludes.