Banks and the potential inflation bubble

Written by Steve Ruffley

There was much talk towards the end of 2013 that the UK economy was getting back on track and that we are set to see gains of up to 20 per cent in the FTSE in 2014. The question is: what could possibly go wrong for the UK?

Well, here it is. The Bank of England (BoE) seems to have no real idea of how to deal with ‘real inflation’ or interest rates. Yet again we see the re-introduction of 95 per cent mortgages in the UK. It seems the UK’s love affair with property is not going to end any time soon.

 The blame lies with the culture in which people today are growing up. Unfortunately knowledge is passed down through the generations, and the majority of people who have had children and who are nearing retirement, are still encouraging and facilitating their children’s debt.

While interest rates remain at this historic low, people will continue to pay over-inflated houses prices at the top of the market. As soon as interest rates rise, another property crisis and credit crunch will strike. Let’s remember that interest rates move in cycles, and have done since they were invented.

The UK housing bubble is like watching a train crash happening in slow motion. There are simply too many people relying on over-inflated property funded by unsustainable debt levels facilitated by ‘old’ money and cheap finance.

The here-and-now problem on the other hand is inflation. Systematically eroding people’s standard of living, it invariably hits the poorest the hardest.

With all that said, it’s not all doom and gloom. GDP is expected to rise this year seeing an increase of up to 2.7 per cent, rather than the predicted 2.2 per cent, which will take the UK back to levels seen in 2008, pre-crunch.

Unemployment is falling and getting ever closer to the 7 per cent threshold to which the BoE links interest rises. This is good news if you think the BoE will drop rates. However, it is unlikely the UK will be the first to hike rates.

Many had high hopes for the UK after the break in BoE traditions in bringing someone in from outside the normal hiring pool. This did not last long. After BoE governor Mark Carney’s opening speech and wanting to address inflation, it was a sure bet that Mr Carney would see to the underlying issues within the UK and not fall into the trap of following the Federal Reserve (Fed).

However, very much in line with the Fed and the ‘will they, won’t they taper QE’ question, the problem for Mr Carney and his waning credibility is what will he do, and what is his actual stance for forward guidance?

Mr Carney fell into the wait-and-see trap, which the Fed started and the European Central Bank (ECB) and BoE whole-heartedly followed. The general consensus was that, by keeping base interest rates low, this would encourage growth. The marginal growth we have seen has been from consumer spending, once again fuelled by increasing house prices and credit availability.

The growth has not come from businesses or from any of the measures set out by the BoE to stimulate growth. All that has happened is we have recapitalised the banks and they are still not lending to small business, which is probably the best way to sustain job creation and growth.

So what measures does Mr Carney have at his disposal for forward guidance? Not a lot. We are rapidly approaching the 7 per cent unemployment rate, and his decision to link a rates debate to this figure was one you could instantly see him regret. Other measures are more asset purchase, but again with the Fed talking of tapering as early as this month, the BoE will certainly be more likely to reduce this than increase it.

The main measure that the BoE has is that the UK now owns the banks. Now we have bailed them out we need them to work for us. The BoE has to pressure banks to lend to small and medium business in a structured and responsible way.

The fact of the matter is there were tough calls to be made and, although Mr Carney has not waved a magic wand and fixed the UK economy, we are still here. In 2014 we will see a rise in rates. The UK has a very large ageing population, with inflation-linked pensions, cash and equity in houses.

For the greater good, the younger generation in the UK is set to suffer further. With rates definitely going up (at some point in the next few years) there will be heavy casualties in the housing markets and a great portion of people who will simply be unable to sustain their debt levels.

2014 is a key year for the UK and my underlying thought is that if you are in the UK and struggling with debt now, the next few years will not be kind.

Steve Ruffley is chief market strategist at InterTrader



The direction of the pound in 2014

Steve Ruffley, chief market strategist at InterTrader, gives his outlook for the UK’s currency:

“In keeping with the view that the UK will be the first to raise rates, we will see the GBP/USD gain strength in the first quarter of 2014 and rising to 1.73289 by the end of the year. We see strong support at 1.5648 and I do not foresee the USD being strong enough to test the 1.53122 so again, after initial dips, I would be buying the GBP on any significant lower levels.”


Comment on Banks and the potential inflation bubble: