U.K. banks raising mortgage interest rates…cause inflation hasn’t fallen as much as expected. Can anyone do an ELI5 as to why?
U.K. banks raising mortgage interest rates…cause inflation hasn’t fallen as much as expected. Can anyone do an ELI5 as to why?
As the title says, numerous banks in the U.K., maybe across the world, are raising interest rates on mortgages, and the given reason is cause inflation hasn’t fallen as much as expected. Can anyone give me a basic inflation, other than greed, as to why they’d do this?
Government lends money to banks. Banks lend money to homeowners.
When inflation is too high, the government charges banks higher interest, so banks charge customers higher interest.
Fewer people take out loans, so there is less cash circulating in the economy, which dampens inflation.
At least that’s how it’s supposed to work.
If it did work that way, it might be all right. But you're forgetting that the banks only have a like 5% reserve requirement. So for every thousand dollars they get in the bank from an account, they can lend out 950 more. And they can do this again and again until it hits zero, which is about 9 times. So you end up turning $1,000 into About 9,000.
not really relevant to money lent to them by the government. Fractional reserve is in reference to people who have deposited savings in a bank, they still have to have money to lend it out, they cannot print new money, only the government can do that.
I'm sure someone else can do a much, much better explanation than I can, but... As I understand it, it comes from the perception that inflation is driven by a "too much demand" problem (ie, too much money in the system chasing the same amount of goods), and by raising interest rates they discourage spending and encourage saving, both serving to reduce demand.
Obviously there are valid questions about whether raising interest rates to deal with a "not enough supply" problem actually helps or causes more harm - and given that the current inflation was initiated by Russia's invasion of Ukraine, which resulted in supply disruptions. The problem was not a surplus of money, but a deficit of goods. And, of course, a lot of things most hit by inflation are impossible to meaningfully reduce demand for, like food and electricity.
I have suspected for a while that raising interest rates to deal with inflation is largely a "when all you have is a hammer, everything looks like a nail" situation: the Bank of England only has one tool - changing interest rates - so when faced with a problem, the only thing they can do is raise or lower interest rates.
Actually, the reason for the inflation was the beer bug back in 2020. And the money printing that went on in very many places. Then on top of that, you had the supply shock from people not working. And that just made it worse.
Inflation in the UK didn't really go into overdrive until Russia invaded Ukraine and caused a spike in oil and gas prices, which fed through to every other part of the economy because literally everything uses oil and/or gas at some point in the supply chain.
They are upping the rates on their fixed rate deals ( 5.84% for the next two years for example).
Because these rates can't be changed once agreed the banks forecast what they think the cost of their borrowing will be over the next two years (based on the central bank/gov interest rates) and set a customer facing rate that is competitive but will make them good money.
They have been setting their rates with the assumption that the government set interest rates will fall sharply this year. That would mean they could give customers an interest rate that's lower than the current government rate now because in a years time the government rate will have fallen and the customer would still be paying the fixed (higher) rate they agreed. (Making the bank good money)
However, inflation is proving more entrenched than expected and the government isn't reducing interest rates like expected. The banks are therefore not offering those lower interest deals to customers as they're not expecting to make it back later.
Primarily because if you continue issuing mortgages at the same rate, then people who get those mortgages will be paying you money that is worth less and less over time. Your mortgage payment might be a thousand pounds per month now and would stay that way for 30 years but in even five years 1,000 pounds will only buy the mortgage company what say 950 pounds would buy today
new money enters the economy from government loans to banks, banks then lend that money on to consumers and businesses. The interest rate charge is effectively the price, by raising the price they’re hoping to decrease the amount of new money entering the economy, which is thought by many to be the main cause of inflation.
Normally new loans/investment creates growth in the economy, so there are more goods and services for that money to be spent on, so prices don’t go up, or at least go up more slowly than new money is entering the economy. But lately, despite new money entering the economy, supply for goods and services has not grown quickly enough (or even shrunk), so more money is competing for the fixed amount of stuff, so prices have gone up (inflation). They only really have one tool they’re willing to use to address the issue, how “expensive”(interest rates) new loans are.