Tuesday, Mar 23, 2010
Interest rates to stay low for a while yet
BBC: UK inflation rate starts to fall
The UK inflation rate fell to 3% in February from 3.5% the month before, official figures have shown.
The drop in the Consumer Prices Index (CPI) inflation rate was greater than the sharp drop analysts had expected.
Retail Prices Index (RPI) inflation, which includes housing costs, remained unchanged at 3.7% in February.
The CPI inflation rate is the measure targeted by Bank of England interest-rate setters, while RPI is often used as a benchmark in wage negotiations.
A letter from the bank's governor is required if inflation is more than one percentage point above or below the government's 2% target.
Posted by luckyjim @ 09:40 AM (2770 views) Add Comment
28 Comments
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1. mark said...
what are the odds inflation will be adjusted upwards after budget or election...
2. estrader said...
Do I understand this correctly...does this mean that anyone who bought a house in January is now around 4.5% worse off thanks to inflation and property price falls? I thought houses were meant to be a protection against inflation...what about all those interest payments on the loan?
3. taffee said...
there are 645 items in the inflation basket including music downloads,flat screen tvs and lip gloss
imo inflation should be the cost of living
1/mortgages
2/food
3/utility bills
4/housprices and rents
almost everything else is discretionary and can be done without....currently its a frace
4. inbreda said...
including mortgages leaves it too open to frigging by the glubberment. They just tell the (ha-hum) independent BoE to reduce IRs and wa-hey! inflation falls. You need to look at the total mortgage payments over the lifetime of the mortgage - in other words use the cost of buying, rather than the cost of repaying at a particular point in time.
5. rickyb said...
Looking through the basket of goods, I don't see any mention of mortgage deposit costs, which I would have thought was a fairly major omission. It does seem ridiculous that the price of the most expensive item that any of us are ever likely to buy, does not figure in some way in the inflation calculations.
6. little professor said...
RPI, which includes mortgage costs, was unchanged at 3.7%.
7. quiet guy said...
Luckyjim,
The title you chose is a bit vague. The phrase "Interest rates to stay low for a while yet" could mean almost anything w.r.t. future interest rates and the time that rates rise.
Do you have any specific ideas about when we will see rates change and by how much?
8. Daopig said...
But there has been a massive drive remove home ownership from the consideration of the masses. Part of the gradual harmonisation with Europe has been tax increases and house price increases. No longer is the Englishman's home his castle.
9. flashman said...
estrader: "Do I understand this correctly...does this mean that anyone who bought a house in January is now around 4.5% worse off thanks to inflation and property price falls?"
The inflation numbers quoted are expressed as annual figures (i.e. we did not have 3% inflation in a single month).
"I thought houses were meant to be a protection against inflation...what about all those interest payments on the loan?"
Inflation effectively eats away at the capital owed by the mortgage holder. When people talk about houses as a hedge against inflation they are often referring to the erosion in real terms of the principal owed.
10. luckyjim said...
QG,
I think the inflation we've seen over the last year was mainly caused by the fall in the pound. This has now worked its way through the system.
If workers had been asking for (and getting) inflation matching pay increases over the past year we would now be seeing inflation staying high or rising further as employers pass on the cost. Obviously this isn't happening because most people feel lucky to have a job at all. If we had seen inflation spiralling in this way the Bank would now be forced to raise interest rates to dampen things down. It seems the economy is damp enough already. That is the only thing that today's news tells us.
We might see wages rising once the election is out of the way and workers are feeling a little bolder. But even this won't feed through to inflation until much later in the year. So I don't think inflation is going to force interest rate rises any time soon.
The other thing that might cause a rate rise would be a run on the pound but so far the government has been happy to see the pound fall.
11. Si said...
The fall in inflation this month is the result of the VAT decrease/increase working it's way through the system. The previous month's inflation result was so high because of it. The fact that inflation is high this month despite that this being no longer a factor is the real issue here.
12. estrader said...
@8 Thanks Flash, I was actually being facetious. I know I'm not earning 3% month on my IL- saving certificates.
"Inflation effectively eats away at the capital owed by the mortgage holder. When people talk about houses as a hedge against inflation they are often referring to the erosion in real terms of the principal owed."
Yes, but if you owe £150,000 you owe £150,000. What you earn is a different matter. Besides, interest on the loan offsets a large portion of any 'benefit' gained by inflation. If the asset isn't increasing in value at the rate of Interest + inflation you have to wonder what benefit is gained. I'm sure when people talk about houses as a hedge against inflation they don't figure these things in their calculations, including opportunity cost.
13. timmy t said...
I'm no statistician but the weighting in the basket of goods looks a bit odd to me. http://www.statistics.gov.uk/articles/nojournal/CPI_and_RPI_The_2010_Basket_of_Goods_and_Services.pdf
Food has gone down - I spend more on food now than I did last year and it's not because I eat more
Housing has gone up yet thousands are enjoying cheaper mortgages than ever before
Alcohol has gone up when pubs are closing everywhere as we turn to cheap booze at Tesco
Fuel and light have gone down 20%.... well my bills haven't
I would have thought bearing in mind the current climate, as taffee points out, the basics become a much higher proportion and the luxuries go out the window.
14. estrader said...
@11, Exactly timmy t. You see it's raining outside while the government weatherman is telling you it is sunny.
15. luckyjim said...
Si,
It's a year-on-year figure so VAT is still playing a part. There was a jump in last month's figure because it was the first month in which we were comparing prices with 17.5% VAT against prices with 15%VAT. The VAT change will continue to distrort the figure until Jan 2011 - then we'll see a sudden drop as Jan 2011 will be the first month of comparing like with like again.
Estrader,
The other question is to ask is what happens to mortgage payments when we have inflation. If you take out a fixed rate mortgage the answer is 'nothing' - your mortgage stays exatly the same. Rent tends to rise with inflation year after year.
The asset only needs to rise with inflation (regardless of interest rate) to hold it's value. The interest is the equivalent of rent.
Many of our beloved baby boomers paid their mortgages off early as, after years of inflation, they found they owed less on their houses than they did on their cars.
16. symo said...
The glorious party also informs us that the output of tractors has incresed.
Horay for Comrade Brown our Supreme Unelected Leader
17. estrader said...
luckyjim
"The other question is to ask is what happens to mortgage payments when we have inflation. If you take out a fixed rate mortgage the answer is 'nothing' - your mortgage stays exactly the same. Rent tends to rise with inflation year after year."
One thing I am certain of - Banks don't exist for my benefit. If they lend out more money than they get back, they would soon be out of business. I wouldn't keep £150,000 in a Bank savings account for 25 years and not expect to lose out due to the erosion of inflation, yet I am expected to believe that a bank would gladly lend me £150,000 for 25 years without any real return, despite taking on risk. No, I've done the maths myself. Inflation erosion is the illusion created to get people on debt treadmills and keep them there. But as always, do your own figuring.
18. flashman said...
estrader: "Yes, but if you owe £150,000 you owe £150,000"
This is not really true, in real terms. A heavy bout of heavy inflation can easily turn the £150,000 into an inconsequential amount. For example, my parents bought a house for £21,000 in 1970. By the time 1980 rolled around, inflation had increased the value of the house to well over £100,000. In the meantime, salaries had risen roughly in line with inflation which effectively demolished the value of their monthly mortgage payments and the mortgage principal owed. During this same period, rents rose roughly in line with inflation, which therefore meant that renters gained nothing from this bout of inflation.
Incidentally, the same house would be worth well over a million pounds. If they had rented all those years ago, they would still be renting now and have no capital to show for it. Half way through the mortgage term, inflation had effectively wiped out their mortgage and of course their monthly payments had taken a chunk out of this already effectively diminished amount. By the end of the mortgage term, the house was owned outright and there were no more monthly repayments (not that it mattered much because inflation had turned the repayments into an insignificant amount). If they were renting the same place they would now be paying about £5,000 in rent per month.
This illustrates perfectly why some people consider a house (or more specifically a mortgage) to be a hedge against inflation.
19. flashman said...
estrader: "The other question is to ask is what happens to mortgage payments when we have inflation. If you take out a fixed rate mortgage the answer is 'nothing'
See my post @18. Wages tend to rise with inflation, which effectively reduces the value of a persons mortgage payment and the principal owed
Even if a mortgage had a variable rate, which also happened to rise in an inflationary episode, then the principal would remain the same (and therefore be effectively diminished by inflation and the accompanying higher wages)
20. estrader said...
Flashman, the question is what could they have made if they invested £21,000 somewhere else. Without the uncertainty of 'ifs', (I remember even you said that the most respected pension companies don't know what inflation is going to be over the next 25 years) interest on the loan plays a *big factor*. Besides, if your parents bought at the peak of 1989 it would have taken them 10 years to get their money back, not counting interest on the loan, the stress of being in negative equity etc.
21. quiet guy said...
@estrader
"the question is what could they have made if they invested £21,000 somewhere else ... Besides, if your parents bought at the peak of 1989 it would have taken them 10 years to get their money back"
I agree that it's useful to buy at the right time in the cycle but if our hypothetical investor chooses to invest their cash in something other than their primary residence, they are aiming to beat house price inflation plus rent.
When you look at the issue from that perspective and considering the relative difficulty of investing in equities, etc I suppose it's not really surprising that the property ownership is so ingrained.
22. Neil B said...
Am I missing something? If the target is 2% why is it a positive thing to have inflation at 3%
23. flashman said...
"what could they have made if they invested £21,000 somewhere else. Without the uncertainty of 'ifs'"
That’s a red herring because most people who buy houses don't have the entire purchase price sitting in their current account. They didn’t have £21,000 to invest because they probably only had a £5000 deposit. Even if they did have the money, no sane young couple would have considered renting a house and betting the £21,000 on the stock market or similar. It was not an investment. They needed somewhere to live so they took out a mortgage and bought a house. That's what people did/do.
You questioned the value of buying a house as a hedge against inflation (during an inflationary episode), so I provided a REAL example of how buying a house worked out as a hedge in a time of high inflation. It is not a hypothetical argument open to debate. Millions of people actually benefited in the same way. It goes without saying that savers and renters faired very badly in the same 1970s inflationary episode.
The simple point is that they bought a house during an inflationary episode (some HPC’ers believe that inflation will take off again, hence the discussion) and it proved to be a great hedge against inflation. Inflation had calmed down by 1989 so your example is not particularly relevant to this debate.
Btw I have no particular belief in the direction of inflation, so it is not something I am recommending as a course of action. However if you or anyone else believes in a hyper inflationary future, then you would do well to consider how a previous generation of mortgage holders had their mortgages effectively wiped out by inflation. In fact, they benefitted so much, that they were able to buy the house that you now rent
24. thelostdecade said...
Flashman, in the medium- to long-term wage inflation tends to move in line with general price inflation, including house price inflation, and all three are mean-reverting. Therefore, I would argue that in the medium- to long-term an individual's ability to borrow and buy a property should be unchanged, and hence property isn't the hedge against inflation you suggest (any increase in house prices is offset by an increase in income and therefore affordability is unchanged). The hedge is in fact yourself and your ability to grow your income at least in line with inflation.
However, as we all know, in the short-term imbalances can and do exist, which present opportunities to act accordingly, but following ten years of low price inflation, low/moderate wage inflation and high/hyper house price inflation I would argue against a house currently being a good “investment” or indeed a hedge against price inflation.
Also, pratically speaking, how useful is the value of your house against price inflation??
25. ana lytics said...
I note that the RPI Index Value for Feb was 219.2, and Jan's IV was 217.9........... 219.2/217.9x100-100=0.60% in one month! Annualising this number to an annual figure (1.0060^12)*100-100=7.40% Annual inflation. RPI Data set below (from ONS website):
2009 Jan 210.1
2009 Feb 211.4
2009 Mar 211.3
2009 Apr 211.5
2009 May 212.8
2009 Jun 213.4
2009 Jul 213.4
2009 Aug 214.4
2009 Sep 215.3
2009 Oct 216.0
2009 Nov 216.6
2009 Dec 218.0
2010 Jan 217.9
2010 Feb 219.2
Inflation (RPI) held at 3.7% in Feb because the RPI Index Value jumped from 210.1 to 211.4 between Jan and Feb 2009 (i.e. last year). Hence, the data "falling out" of the annual figure matches the jump in Jan/Feb this year. Hence RPI stayed constant.
I notice that the Index Vals for March and April 2009 were 211.3 and 211.5 (respectively) - i.e. VERY close to the Feb 2009 figure, which means if the Index Val for March 2010 is greater or equal than Feb 2010's figure, then RPI will RISE next month. Pretty much the same story for April too (a very slight = 0.1, rise in Index Value between Feb and April 2010 will keep inflation at 3.7%, anything more = RPI will RISE).
Hence, I can't see RPI falling before May 2010.
CPI is a different data set (below), but prices ROSE in Feb (by 0.44%), but just not as fast as Jan-Feb 2009 (hence the fall in CPI this month)...........
2009 Jan 108.7
2009 Feb 109.6
2009 Mar 109.8
2009 Apr 110.1
2009 May 110.7
2009 Jun 111.0
2009 Jul 110.9
2009 Aug 111.4
2009 Sep 111.5
2009 Oct 111.7
2009 Nov 112.0
2009 Dec 112.6
2010 Jan 112.4
2010 Feb 112.9
Looking at Mar and Apr 2009, the IVs rose 0.2 and then 0.3 respectively, so small increases of this nature in Mar and Apr 2010 will keep CPI at 3%..........
Hence, IMHO, both CPI and RPI won't fall by much (if anything) before the election............ due to the stable inflation index values last springtime.
26. flashman said...
thelostdecade: You have completely missed the point of this argument, which is that a bout of high inflation greatly reduces the real value of the original sum borrowed on a house. It is such a simple concept. You even go so far as to say that wages rise in line with inflation, which is of course usually true. Why then can you not see that if wages rise while the original sum borrowed remains the same, the value of the debt will become smaller and smaller in relative/real terms?
No one (in this argument) has claimed that there will definitely be high inflation. I personally don't think so but if there were an extended bout of high inflation then holders of mortgage debt would benefit in the way described above. Even 10 years of average inflation will greately reduce the effective value of the original mortgage debt
Also, why are you arguing against a house "currently being a good “investment”"? Nobody is claiming that it is.
27. thelostdecade said...
Flashman, rest assured your rudimentary analysis is not lost on me – I fully appreciate that WAGE inflation cheapens the real cost of servicing debt, but lets be clear in the short-term general price inflation does not have the same effect as wage inflation.
Also, suggestions that houses are a hedge against general price inflation are spurious, especially in the long-term when it is your labour/ability to generate a higher income that is your hedge against general price inflation (i.e. rising living costs).
And, a hedge has no use if the individual either 1) overpays for the hedging asset, or 2) you cannot realise the value from the hedging asset, or are you suggesting individuals should periodically release equity from their properties to cover their rising living costs (i.e. the consequence of high levels of general price inflation)?
Get the picture yet?
The best hedge against rising living costs (i.e. general price inflation) that I’ve found are inflation-linked certificates, like those offered by NS&I.
(p.s. picking me up on the “investment” point was quite pathetic)
28. flashman said...
thelostdecade: "I fully appreciate that WAGE inflation cheapens the real cost of servicing debt"
Well there you are then. By your own earlier admission, wage inflation tends to goes hand in hand with price inflation so what is the point in claiming that it is one rather than the other that has an effect? Inflation is inflation and it does what it does. My analysis is rudimentary because I am limiting myself to such a simple point that adding anything extra is superfluous (unless of course anyone feels the need to add as much confusion as possible to obscure the fact that they missed the point). I am not claiming that there will be inflation and I am not arguing that buying a house is a good idea at the moment. I am only arguing that if we do end up with a nasty bout of inflation then there is some benefit to holding mortgage debt.
If you agree and understand that "inflation cheapens the cost of servicing debt" then you agree with my ONE and ONLY point. I picked you up on the investment point because you appeared to be picking me up on a point I didn't make. My best guess at the time was that you balked at the very idea of any benefit being ascribed to purchasing a house and decided to go into bat against an unarguable point (that you actually agreed with). I also guessed that in doing so you added imaginary detail to a simple argument in an attempt to find something to argue with. I now have no doubt that you understand my point more than most. I will admit to sometimes getting a bit irritated by the tendency of some people on this site to reduce arguments to the level of a football chant. They get all shity if anyone even looks likes they are backing the "other team" and spray as much irrelevant nonsense at the "opponent" as they can. You almost certainly do not belong to this camp so perhaps I shouldn't have assumed that you do. I am a professional analyst and I have learned over the years to stick to and prove one point at a time. People will still read more into a simple point than was intended, so I try to stay away rom broad brush concepts on this site.
Have a good day and apologies for any tart comments.