The Agonising Dilemma of Interest Rates versus Wages

It must be a pretty nerve-racking job to be an economist in today’s UK. There are so many variables to consider, so many reports that one month indicates one thing and then apparently seem to contradict themselves just a few months later. While most would agree that the current government has done a pretty good job of steering the UK economy on the right path, with the Gross Domestic Product appearing to increase a few Screen Shot 2014-01-28 at 7.33.10 PMpercentage points, when compared to 2012, there are still many variables that have to be considered. Unemployment is still high, although it is falling just a tad. Consumers seem to be spending again, especially over the recent Christmas season, perhaps clinging to the hope that the worst is over and better times are ahead. But moving forward into 2014, there is a very slippery slope that confronts economic policy, when considering what mortgage interest rates should be and how they will affect homeowners.

The Bank of England Makes the Decision

The Bank of England is tasked with a heavy burden: where to peg interest rates, especially in regards to home mortgages. Their rates have been at a historical league low of 0.5%, which has allowed a lot of lending institutions to provide mortgages to a wide variety of people. You have seen what happened next. The housing market took off like an Apollo rocket headed to the moon and so far, has not looked back. But here is where a little dose of Russian roulette is involved. If the Bank of England decides to raise interest rates, but both unemployment and wages don’t increase, either ahead of time, or simultaneously, it could lead to disaster. An association known as the Council of Mortgage Lenders recently reported that mortgages jumped by almost 30% in the last 12 months ending this November. Yes, a lot more houses have been purchased. That has been good for the economy. But the Bank of England also estimates that the average household debt remains at £87,000, which is dangerously high.

Can real wages outpace mortgage rates?

Given the fact that the UK economy is still fairly shaky, especially with the manufacturing sector not producing as much as the Coalition would like, is there any real chance that wages will increase, even by 5%, across-the-board anytime soon? Nobody has a crystal ball, but given the current economic realities, it appears highly unlikely. If interest rates jumped from their current basement of 0.5% to say, 3%, the number of households that would be challenged to meet their increased mortgage payments would balloon. According to the Bank of England’s own estimates, what they referred to as “vulnerable mortgagors” would more than double and nobody wants that. So the Bank is going to have to proceed with caution, hopefully not raising mortgage rates until there has been a substantial drop in the unemployment rate, coupled with an increase in real wages.

Stay Out Of Harm’s Way

If you are able to budget your household expenses in such a way that you can put aside some money for savings on a monthly basis, your best bet is to look into ISA Accounts. With these great savings accounts, you won’t pay any taxes on the interest that you earn and you will also be safe in the knowledge that you’re getting excellent rates of return. While you cannot control what the Bank of England will do, you can certainly put your own financial house in order.

Image courtesy of: Stuart Miles


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