Buy To Let
Young people dubbed the winners from high interest rates
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Emma LunnThe Resolution Foundation says that consistently high interest rates could lower house prices and make saving into pensions easier, benefitting young people.
A report by the think tank found that the interest rate surge, which began in December 2021, has delivered the biggest wealth fall for British households since World War II.
But although household wealth across Britain has fallen by £2.1trn over the past year, the younger generation could be the winners if higher rates are sustained.
The report Peaked Interest? – part of a partnership with the abrdn Financial Fairness Trust – examines the impact of rising interest rates on household wealth, and what a ‘new normal’ of higher rates could mean for living standards and wealth accumulation in the future.
Household wealth
The report notes that the UK has experienced an unprecedented wealth boom in recent decades, with total household wealth rising from around 300% of national income in the 1980s, to 840% – or £17.5trn – by 2021.
However, rising interest rates have caused mortgage rates to rise, house prices to fall and the price of Government and corporate bonds to plummet.
Falling bond prices have reduced the measured value of pension assets, normally the biggest single source of household wealth in Britain.
The foundation’s estimates suggest total household wealth has fallen to 650% of national income in early 2023 – a cash fall of £2.1trn over the past year and the biggest fall as a share of GDP since World War II.
If higher rates remain, it could drive further falls in wealth to around 550% of GDP. This would end the 40-year wealth boom that has been a key driver of intergenerational inequality – with surging house prices and pension values largely benefiting older generations at the expense of young people, many of whom have been locked out of home ownership altogether.
Lower house prices
The foundation’s analysis shows that persistently higher interest rates would have two key long-term effects: lowering house prices and making it easier to achieve a decent standard of living in retirement by raising rates of return on pension savings.
Higher interest rates could reduce the house-price-to-earnings ratio from its 2022 peak of 8.9 to 5.6, a level not seen since the turn of the century. Were this adjustment to happen over five years, it would mean house price falls of around 25% in cash terms.
Although rising rates are causing a crunch for mortgagors, falling house prices will benefit prospective house-buyers.
First, it will reduce the deposit barrier for first-time buyers. Second, while rising rates add to the cost of repaying mortgages, this would be more than offset by the lower mortgage amount needed to purchase the house.
Pension savings
According to the Resolution Foundation, before the pandemic a typical worker would need to save about £5,000 a year to achieve an income in retirement worth two-thirds of their income prior to retiring.
But with today’s higher interest rates, the same worker would only need to save around £3,000 to achieve that same standard of living in retirement.
Ian Mulheirn, research associate at the Resolution Foundation, said: “Over the past four decades wealth has soared across Britain, even when wages and incomes have stagnated. But rapid interest-rate rises have ended this boom and brought about the biggest fall in wealth since the war, of £2.1trn.
“Those with significant mortgages will be hit by these major changes. But there are winners too from a shift to a world of higher rates and lower wealth. Higher returns will make it far easier for younger people to save for a pension that delivers a decent standard of living in retirement, while lower house prices will make it easier for younger generations to get on the property ladder and others looking to trade up.
“The future path of interest rates is very uncertain. The current surge could be a blip, or herald a new era for the UK. Either way, policy makers should focus more on whether and how to insulate households from wild swings in their fortunes from these forces well beyond their control.”