Matterhorn or Table Mountain?
No, it’s not a question of what you’d like to ski down, or even the view you’d like for your apres ski.
It’s the question that has been exercising economists’ minds lately and it relates to interest rates.
Interest rates would be like Table Mountain
The chief economist at the Bank of England, Huw Pill, said recently that interest rates would be like Table Mountain – a steep rise followed by a long period at the top and then a reduction.
The alternative is a steep rise, then a steep fall – the Matterhorn option. The implications of which way central banks choose to go could be big for those buying a ski home, in two ways.
But before that, a brief macro-economics primer…
There’s a complex relationship between prices (including property prices), interest rates and exchange rates. It’s something, incidentally, that your trader at Smart Currency will be happy to go explain to you over the phone if you prefer.
As inflation rises (as it did post-pandemic and with the war in Ukraine), the central bank raises interest rates to deter both business and individuals from spending as much. As demand in the economy falls, so do prices, and inflation returns to where it should be – around 2%.
‘Monetary tightening’
‘Monetary tightening’, aka raising interest rates, particularly affects property prices as new buyers cannot afford such large mortgages and some of those who can’t pay their mortgage any more are forced to sell. That’s why in most countries lately, property prices have fallen back again. That may be good news for property buyers.
However, as a country raises its interest rate, money flows into that country and the exchange rate strengthens. Because inflation was so high in the US, the Federal Reserve went on an aggressive round of interest rate hikes that took the dollar to euro rate up by 20% by September last year. Then as they eased off a bit, and the European Central Bank went into overdrive with rate rises, so the euro strengthened.
The Bank of England has raised interest rates 14 times in a row since November 2021, helping to support sterling. Now that has ended and sterling fell to a six-month low.
The interest rate mechanism of controlling inflation takes months to work. So the measures that the Bank of England, Federal Reserve and European Central Bank have implemented already, won’t be fully felt for maybe a year. For example, some householders will be on fixed rate mortgages and won’t feel the pain until those end. As companies find demand for their products dropping they will eventually lay off staff, or go bust, but that won’t happen immediately.
Consequently, each of the countries in Europe or the UK could go into recession next year, at which point central banks will start cutting interest rates. Then we will see mortgages come down, and maybe see house prices rise.
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Apr 29, 2024
