Economic turmoil matters for family finances as well as financial markets

The market’s reaction to last Friday’s fiscal statement will have a material impact on household incomes; in the short-term through higher inflation; in the medium-term through higher mortgage payments; and, in the long term as higher borrowing exacerbates tax and spending trade-offs, the Resolution Foundation said today (Monday).

The size of the Government’s fiscal package last Friday – notably the £45 billion of unfunded tax cuts – and lack of any detail of how they intend to ensure the sustainability of the public finances, is putting downward pressure on the exchange rate, and upward pressure on interest rates.

The Foundation notes that, as imports make up around a third of households’ consumption, the further depreciation of sterling over recent days – it has fallen by around 2.7 per cent against the weighted average of other currencies since close of trading on Thursday – will push up inflation, which in turn will have the effect of reducing living standards by around 1 per cent. Most of that impact will be felt over the course of the next year, further exacerbating the UK’s cost-of-living squeeze.

Markets are today expecting the Bank of England to raise interest rates to hit 6 per cent next year, up from 5 per cent last Thursday. This would have a huge impact on mortgagor households – immediately for the minority on variable rate mortgages, or over time for those whose fixed rate deals come to an end. UK Finance data suggests that 1.8 million households are due to roll-off fixed term mortgages next year.

The Foundation notes that for a homeowner with a £140,000 mortgage and residual maturity of 17 years – the example given by the Bank of England in the August Monetary Policy Report – rates rising to 5 per cent would mean their monthly payments rising by around £190 relative to rates staying at 2.25 per cent. Interest rates of 6 per cent would push this typical mortgage payment up by around a further £80 a month, or roughly £1,000 a year.

Another key reaction to last Friday’s fiscal statement was an increase in gilt rates, with the two-year rate going up by around 1 percentage point since Thursday, and the 10-year rate going up by around two-thirds of a percentage point.

These shifts will add around £14 billion a year to borrowing by 2026-27, and come in the context of a fiscal statement which saw total borrowing rise by over £400 billion over the next five years.

The Foundation says that with the Government ruling out future tax rises – and indeed implying that further unfunded tax cuts are coming soon – persistently higher debt interest costs risk requiring the Chancellor to announce significant spending cuts at some point in the future. Its analysis shows that even before the latest rise in interest rate expectations, to have public sector debt falling by 2026-27 would require spending cuts of around £35 billion.

Torsten Bell, Chief Executive of the Resolution Foundation, said:

“Last Friday’s growth plan was based on the firm belief in the markets, but recent events suggest that the markets don’t share the same belief in the growth plan.

“The turmoil we are seeing matters for family finances as well as financial markets. The major moves since Friday don’t just mean the Government seeing its borrowing costs rising by a further £14 billion, ultimately requiring less spending or higher taxes, they will affect family finances.

“The surge in interest rate expectations has already added another £1,000 a year to the coming increase in mortgages for a typical borrower, while sterling’s fall means more expensive imports feeding through to higher inflation and knocking yet another one per cent off our living standards.

“This is a painful reminder that economic policy is not a game.”