Within hours of the Bank of England raising its main interest rate to 1 per cent in May and warning there would be more to come, mortgage lenders got busy pulling some of the crazy-low rates they had been offering.
Twitter was alive with people boasting they had secured a five-year deal at 1.2 per cent just days earlier. Almost overnight rates doubled, with financial markets judging the central bank would raise its main interest rate to 2.5 per cent within a year.
Even 2.5 per cent will still be a very low rate. Since the Bank of England was founded in 1694 its Bank Rate (under various names) has been 2.5 per cent or below for only about a sixth of the time it has existed. Most of that was due to the emergency rate of 2 per cent that began with the second world war and ended more than a decade later. Almost all the rest occurred in the past 13 post-banking crisis years, when it was under 1 per cent.
My own calculations show the BoE’s official rate has a daily average of 4.66 per cent since the bank was founded. Omitting the past few peculiar years pushes that up slightly to 4.83 per cent.
My current bedtime reading is A History of Interest Rates by Sidney Homer and Richard Sylla. It explains that in 1694 the new Bank of England set its first rate at 6 per cent, chosen to match the maximum allowed for private loans under the Usury Act 1660. That rate was cut to 5 per cent in 1714 and Bank Rate followed it there for 100 years.
Throughout the reign of Queen Victoria (1837-1901), money was lent at 5 per cent and borrowed by the government at 3 per cent — despite the uncertainty created by frequent wars and the occasional banking crash. That safe, guaranteed return on “consols” — The Funds as they were known — supported the income of aristocrats and the growing wealthy middle classes.
Over most of the 19th century inflation was fairly flat and wages doubled. The poor were allowed to get richer — even if the rate of growth was relatively slow.
So the market’s predicted 2.5 per cent Bank Rate for 2023 would barely be half the typical rate over most of the BoE’s 328 years. If the economy returns to what used to pass for normal, we should expect a Bank Rate of 4 per cent or 5 per cent. That can only make borrowing more expensive, which would be normal too.
Homer and Sylla also go much further back, revealing that the maximum rates allowed in Mesopotamia from 3,000 to 400 BCE were between 20 and 33⅓ per cent. These are not bank rates, of course, but the actual interest charged to individuals when they borrowed money to buy silver or grain.
Our banks today lend like Mesopotamians — the average credit card rate for April was 26.6 per cent (annual percentage rate), according to finance website Moneyfacts. That is five times a rate that would have been banned until the Usury Acts were repealed in 1854. Even the Romans banned lending at rates above 12 per cent. In Renaissance Europe, where modern banking was invented, money was lent out at between 10 and 15 per cent.
Never for the past 5,000 years were rates as low as 1 per cent — until February 2009. In 2012, when the Bank Rate was 0.5 per cent, the BoE ensured low rates were passed on to borrowers by lending money to retail banks at 0.75 per cent through the Funding for Lending Scheme.
Four years later the Term Funding Scheme lents £192bn to banks and others at as little as 0.25 per cent, the same as Bank Rate at that time. The banks dutifully cut rates on mortgages, leading to the borrowing enjoyed recently by homebuyers at rates beginning with a 1. They also slashed rates on savings, which are only just beginning to show the first hints of recovery.
All this is being brought to an end by inflation which is now 11.1 per cent, 9 per cent or 7.8 per cent depending on which you believe of the three main measures (yes, there really are more than that) published by the Office for National Statistics.
Unlike Victoria’s reign, where prices at the end of her rule were lower than at the start, Elizabeth II’s 70 years on the throne have seen prices rise every single year bar one by an average 5.14 per cent. The Monetary Policy Committee (MPC) was created in 1997 to hold inflation at 2.5 per cent as measured by the Retail Prices index excluding mortgage interest (RPIX) — later changed to 2 per cent measured by the CPI.
Since its first meeting in June 1997, the nine MPC members have solemnly sat down every six weeks wondering whether to raise or cut rates and then — whichever way that vote went — deciding almost every time that a quarter of one percentage point would be adequate. Over those 25 years CPI inflation has averaged 2.0 per cent. Job done.
That was partly due to a new lever given to the MPC called quantitative easing (QE). This mechanism magicked money out of thin electrons and in a little over 10 years created £895bn that was used almost exclusively to buy back government debt. In that decade the MPC invented the one thing most politicians tell us does not exist, becoming the Money Tree Policy Committee.
Whatever QE did to economic activity — it was supposed to increase it but in March this year growth was minus 0.1 per cent after being flat in February — printing that much virtual money inevitably boosted inflation.
Now, as inflation takes off, the only way the BoE can try to control it is by raising the Bank Rate. And the cost of money lent to us can only go one way — up, up and, probably, up.
Paul Lewis presents ‘Money Box’ on BBC Radio 4, on air just after 12 noon on Saturdays, and has been a freelance financial journalist since 1987. Twitter: @paullewismoney