Why Mortgage Interest Rates WILL NOT Rise – UK Buy-to-let Mortgages

Hi Ranjan

As a property investor and economist I enjoy watching your videos but I found this one unconvincing and indeed misleading.

Firstly, govt debt in the UK is, as you say, c.100% of GDP now but you state that govt debt to GDP "has never been that high". This is incorrect. At the end of WWII it was around 250% and didn't fall below 100% until 1962.

Your premise that govt can't push up interest rates because it wouldn't be able to afford the extra cost of funding it's debt is flawed not only because interest rates were raised at times after WWII when govt debt to GDP was much higher but also because the govt borrows almost entirely on a long term fixed rate basis through long term gilt issues. Therefore, a rise in short term interest rates doesn't directly increase the govt's cost of borrowing in a material way. Moreover, the Bank of England sets short term interest rates and it has a mandate to target 2% inflation so rising inflation is likely to provoke the Bank to raise Bank Rate (i.e. short term interest rates) if inflation looks like it will be above 2% on a sustained basis unless this mandate is changed.

You say that the fact that inflation hasn't risen significantly despite all the electronic money printing through QE is because every country is doing it. Although it is true that one country printing money alone is likely to put downward pressure on its exchange rate, risking higher import price inflation, your logic is incorrect. The reason massive money printing hasn't caused significant inflation across the developed world is that the velocity of circulation of money has fallen because of the situation created by the pandemic. As economies recover, central banks may well need to withdraw this "monetary overhang" through reverse QE and raising short term rates to avoid an overheating economy and rising inflation. Thus the threat of higher short term interest rates is real over the next few years.

You talk about Federal Reserve intervention in the US mortgage market. Firstly, you talk of a guy in Idaho with a Freddie Mac mortgage. This shows a lack of understanding of how the US mortgage market works. Freddie Mac (and Fannie Mae) do not make mortgage loans to consumers. They are mortgage funding institutions that provide lenders with the funding they need to make loans. You mention that the US Federal Reserve is buying US mortgage debt and if they raise interest rates it will cave in the securitised mortgage assets they have bought. Again, this is wrong because US consumers borrow overwhelming on a full term fixed rate basis (the most popular mortgage is the 30 year fixed rate mortgage where the interest rate can never rise). Less than 1% of US mortgage advances are now on a short term fixed rate basis (all the rest are full term fixed rate). Since the mortgage debt the Fed has bought is all on a full term fixed rate basis, it means the Fed can raise short term interest rates without impacting the mortgage payments of the borrowers whose mortgages they own or other existing US mortgage borrowers.

If you don't mind me saying, it seems to me that in your case a little bit of knowledge is a dangerous thing because you are drawing conclusions about where short term interest rates might go and providing comfort to property investors based on a false understanding of the economy.

Well said Rob Thomas. This article is misleading and only the opinion of the writer.

What virtually everybody misses is that QE is free money….. yes it really is.
Rough figures, Government debt £2 trillion of which £1 trillion is QE (printed money). The Treasury never has to pay this back as it’s owed to the Bank Of England who’ve created it by adding some zeros on their computer. Hence the £475 billion borrowed between 2009 and 2012 is still on the books not a penny has been repaid. It will just sit on the books forever.
Interest on this QE money does not have to be paid it’s been created by the B of E and given to the Treasury for free. (Yes they buy gilts in the market but that’s just a fudge way of getting the money across). Technically there is a coupon and this is paid by the Treasury to the Bank but they simply return it immediately back to the Treasury. So effectively no interest has to be paid.
A large proportion of future Treasury borrowing will be via QE.
So it’s free money. Only downside it can create inflation although didn’t during the Financial Crisis of 2008/2009.

Hi Dylan

You're almost right. When the Bank of England (BoE) engages in QE it is buying gilts (govt debt) with newly created electronic money. For example, where it buys £1 billion of gilts from a pension fund (the most likely seller) it credits the pension fund's bank account at a commercial bank (say Barclays) with £1 billion.

If Barclays doesn't immediately lend this money to someone else it becomes part of Barclay's reserves at the BoE (deposits to you and me). The BoE has an extra £1 billion of assets (the gilts) and £1 billion of liabilities (the new Barclays reserves).

Commercial bank reserves at the BoE are remunerated at Bank Rate (currently 0.1%) so this isn't quite free money for the BoE (as you say it has to return the interest on the gilts to the Treasury so the assets earn it nothing but equally it means the Treasury is paying nothing on this debt as you say).

If the BoE decides to raise Bank Rate substantially in the future it will come with a cost of having to increase the amount it pays to commercial banks for their reserves. At that point the Treasury might have to reconsider clawing back the interest on the gilts to compensate the BoE for the cost of QE. So, for the govt as a whole (including the BoE), QE isn't entirely costless unless Bank Rate is 0%.

Great explanation Rob many thanks.

Reply to the comment left by Rob Thomas at 11/07/2021 - 12:15
Wow Rob,

I'm glad I don't get into a debate with u ha ha. U know your stuff.

I like to think I know my bits on investing, got about 15 mates to start pensions the last few years, had a pension for me kid since she was about 4, I invest wisely. But u on another level with your stats. I know just the round figures & use the saying 'The only way to make money out of property is to hold it'.

I don't think rates will go up that much cause too many people have borrowed at cheap money & once their fixed deal ends, they gonna' struggle at the new higher rates, so they may have to come back down. But if u disagree, I ain't arguing ha ha. None of us know, or we'd have all bought tons of houses years ago. Ooh I did & now can't ruddy sell 'em cause the tenants can't move any more cause of Govt & Council interference, but there I go again ranting off topic.

I tell u what I do need is & I'll pay once a year, is How to reset the Capital Gains base cost on investments when u have two funds. I know how to do it on one fund, but not the formula for two. Anyone know, please private message.