In the UK, the Bank of England has proceeded to make a series of 13 increases in the lending rate since December 2021, supposedly in an attempt to control the rate of inflation. It's currently at 5%, but it is highly probably that this week will see another rise to 5.25%, and many think it will reach 5.75% by the end of the year.
I challenge any economist or banker to provide a coherent argument in favour of such a policy.
The standard argument is that if you raise interest rates, people and businesses will be less tempted to borrow money and this will tend to reduce the amount of money in circulation - and this has the effect of reducing inflationary pressure. After all, as the Bank of England admitted in 2014, commercial banks create money - effectively out of thin air - when they make loans. If people hold back from borrowing more because the interest rates being charged are too high, this will indeed tend to reduce the amount of money creation by the commercial banking sector.
However, there is a glaring problem with this story, linked to the fact that virtually all mortgages in the UK involve variable rate loans. According to Which?, the vast majority of loans have fixed terms that only last for 2 or 5 years. And that means that people can be hit by massive increases in interest charges when those fixed term periods come to an end. This can mean having to find £500 more every month for a mortgage on a home worth £500 000.
Where does that extra £500 a month go? Well, it obviously goes straight to the commercial bank that made the initial loan. And that's why the Bank of England's sequence of interest rate hikes has been a fantastic deal for the banks. Their profits have soared.
For example, this morning we learned that HSBC doubled its profits in the first half of 2023 to a very impressive £17 billion. While the bank is clearly a multinational entity, HSBC UK accounted for about 22% of the group's total pre-tax profit in that period.
- NatWest reported a 24% increase in first half year profits to £7.7 billion.
- Lloyds pre-tax profits also went up 23% to £3.8 billion.
- Barclays profits were up 24% at £4.5 billion.
So, it seems plausible that every time the Bank of England raises interest rates, there will be champagne corks popping in the City. That is because the Banks can "earn" extra money when they are "forced" to increase the interest rates, despite having done absolutely nothing to merit the extra money.
Of course, when the banks make bumper profits, it means that they will be able to pay bigger dividends to their shareholders. According to the Guardian report, HSBC's bumper profits means that it is planning to hand out $2 billion in divided payments worth 10p a share, as well as an additional $2 billion share buyback. The bankers themselves will also be expecting bumper bonuses. Indeed, HSBC has put aside an extra $200 million for performance related pay for staff compared with last year, when they paid out £3.4 billion in bonuses to top performers.
In other words, the brilliant Bank of England policy doesn't remove money from circulation. It simply moves billions of pounds from working people in the UK, and puts it directly in the pockets of bankers and their shareholders. Pure genius.
The fact is that this situation could be easily fixed by ending the insane system of variable rate mortgages. In France, you can get fixed rate mortgages for the entire term of a mortgage. It can be 20 or even 25 years. And the rates can be very reasonable - even now. For example, one website talks about rates for resident buyers of between 2.8% and 3.1% over 25 years. But even non-resident buyers can get 25 year fixed rate loans. This means that when you take out a loan, you know exactly how much you will be paying every month until the loan is paid off. There is no way that the bank can be allowed to increase the interest rate.
Of course, if at some stage, the interest rates drop, you can always take out another loan and pay the first one off. Seem's sensible to me.
For me, it should simply be made illegal to make loans that don't have fixed rates for the entire period. If that was the case, then it would be true that when the Central bank raises the base rate, it would have the desired effect of decreasing the incentive to take out additional loans, without meaning a massive transfer of people's hard-earned cash to bankers.
As it stands, the current system is absurd. When the Bank of England raises the rate, it increases the cost of finance for existing loans not just for individual citizens, but also for businesses. Suppose you have a business with a lot of debt. If the brilliant economists at the Bank of England ramp up the interest rate, that means you will have to pay more to service the loans, and you will be faced with the choice of either increasing your prices to customers, or go out of business.
If it is the first option, then it should be obvious to anyone who thinks about it for five minutes that this will have exactly the opposite effect to what was intended. It will directly lead to inflation.
Of course, there will be those in the banking sector who think that this way of trying to control inflation is brilliant. It is - for them.
As I say, the solution is actually simple. Variable rate loans should be abolished.