Are rates really going up?
I'm sure you will have heard that interest rates are going up. Are they really?
Are interest rates really going up?
We recently said that the Bank of England Base Rate is at the highest since 2009. In absolute terms, that is true. But that is not the whole story!
Moving to 1% was considered a shock — reflecting how we have become used to cheap money. We have lived with the lowest rates for 300 years.
But we should not consider interest rates in isolation. Interest is what we pay to borrow and it represents the cost of money. On the other side of the scale is inflation. Inflation chips away at the value of money over time. With inflation at 10% (to keep the maths simple), £1 in your pocket will only buy 90% in a year compared to what it will buy today. Inflation has claimed the other 10%.
Inflation chips away at savings but it also chips away at debt. This makes money cheaper.
So the real rate of interest is the absolute rate minus the inflation rate.
With interest at 1% and inflation at 7%, the real rate of interest is -6%.
We are in uncharted territory here. Real interest rates have gone negative in the past, but not to -6%. When inflation spiked to 8% in 1992, the interest rate was 12% giving a positive real rate. Even in the 1970s, when inflation touched 20%, interest rates were as high as 16%. Negative, but not as negative as now.
The predictions are that inflation will top 10% by Christmas. It seems highly unlikely that interest rates will keep pace so we will see even more negative rates yet.
Economists and investors have never seen this situation before. There is no precedent to follow. But we think this is the perfect time to invest, especially if there will be a dip in houses' absolute prices, which seems likely.
Fortunately, we are not alone. We should get some advance warning of real rate-induced troubles from Lithuania. Currently, Lithuania has inflation at 16%, giving negative real interest rates of -16.9%. This is an economy to be watched.