Five years of emergency measures – welcome to the new normal

The Bank of England needs to raise interest rates soon, says Matthew Lynn. Because the longer it leaves it, the harder it's going to be.

If it was a marriage, it would be the wooden anniversary, for which the traditional gift for your significant other is something made of silver.

Next Wednesday, if anyone reading this happens to be strolling past the Bank of England, perhaps they could drop off a small gift. Why? Because that will be the day the Bank celebrates five years of 0.5% interest rates.

The trouble is, celebrate' is not really the right word. In fact, while rates at 300-year lows have obviously been a huge help to some people, there is very little evidence that they have created an enduring, sustainable or balanced recovery. The longer they go on, the harder it will be ever to get them back to normal again.

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On 5 March 2009, the Bank's Monetary Policy Committee (MPC) took the historic decision to cut British interest rates to the lowest level since the Bank of England was created.

They had already been cut and cut again as the financial markets crashed in the autumn of 2008, but it was becoming increasingly evident during that winter that this was not merely a panic in the stock and money markets. The real economy was falling off a cliff as well.

Between October 2008 and February 2009, rates had been cut six times, but at the March meeting the MPC decided to halve them again, from 1% to 0.5%. At the same time, the Bank added another £75bn to its programme of quantitative easing.

At the time, this was sold as an emergency measure, a short-term response to an extraordinary crisis. No one was saying exactly how long rates would stay at those levels. A year, perhaps two at most. But it was certainly not envisaged that it would be a new, permanent rate. And yet here we are five years down the road, and rates are still at 0.5%.

Of course, for some people that is indeed a milestone worth celebrating. If you happened to have a big mortgage, then your monthly repayments went down dramatically and have stayed down ever since. Even better, if the property was in London, its value will have gone up a lot as well.

The growing army of buy-to-let landlords has profited handsomely, as debt interest is usually the major cost they face, and that has come down while rents have risen. Likewise, if you happen to be a bank with a ruined balance sheet, then you will be thankful for low interest rates. It has allowed you to borrow all the money you need, and gradually to repair your financial health.

Many companies have like zombies been kept alive by cheap debt, whereas they might well have gone out of business if they had had to pay more normal levels of interest. And let's not forget the government, the biggest borrower of them all. It has seen its interest bill slashed, and the Bank has been helpfully buying its debt as well.

Yet for every winner, there is a loser and probably many more of them. Savers have been hit hard, seeing the returns on their money virtually wiped out. Pensioners, along with anyone approaching retirement age, have seen annuity rates collapse.Many young people have been locked out of the property markets, because prices have been kept artificially high.

Some companies have been kept alive but many of them were not worth saving. They might be kept going, but they are never going to grow significantly again. Overall, the losers are likely to outnumber the winners and they are probably more deserving as well.

The real problem, however, is something else. It is that as the years drag on, it is impossible to spin 0.5% interest rates as a temporary measure. Emergencies simply don't last that long. Instead, near-zero rates have become the new normal.

In the first year or two, people did not respond dramatically. They thought interest rates would go up again, and probably quite sharply, and they planned their finances accordingly. Likewise, companies operated on the assumption that rates would go up soon-ish.

But as the years pass by, that becomes harder and harder for people to imagine. Remember, not only is it five years since rates came down to 0.5%, but it is even longer since they last went up (5 July 2007, in case you are wondering when the base rate went up to 5.75%).

Some workers will be getting well into the first decade of their career without ever having seen a rise in interest rates. They can hardly be blamed if they don't know what one looks like, and go out and borrow money accordingly.

And yet once individuals, companies and, of course, the government, have loaded themselves up with debt on the basis that rates are only 0.5%, how can they possibly be prepared for 3% or even 5%? After all, it is hardly reasonable to expect them to keep preparing for normal' rates when there is no evidence of such rates actually arriving.

The Bank needs to recognise that if it goes much beyond five years, it will be at the point where it can no longer raise rates. Japan slashed rates 20 years ago, and they are still there and yet near-zero rates have not fixed that economy either.

We are going the same way and may well already be there. In which case, in the spring of 2029, we'll be celebrating' the arrival of the third decade of emergency' interest rates.

Matthew Lynn

Matthew Lynn is a columnist for Bloomberg, and writes weekly commentary syndicated in papers such as the Daily Telegraph, Die Welt, the Sydney Morning Herald, the South China Morning Post and the Miami Herald. He is also an associate editor of Spectator Business, and a regular contributor to The Spectator. Before that, he worked for the business section of the Sunday Times for ten years. 

He has written books on finance and financial topics, including Bust: Greece, The Euro and The Sovereign Debt Crisis and The Long Depression: The Slump of 2008 to 2031. Matthew is also the author of the Death Force series of military thrillers and the founder of Lume Books, an independent publisher.