Inflation & Interest Rates Up, Wages & House Prices Down

In the last year, the Misery Index – Inflation Rate plus Unemployment Rate – has been soaring, as I predicted it would. Despite the Tories assuring us that slashing State Spending would create a private sector boom that would produce an avalanche of new jobs, all their austerity has done is to send the recovering economy back into recession, and sent unemployment heading up towards 3 million. That is despite the fact that, so far, the Liberal-Tories have only implemented 6% of their planned austerity measures! Despite the Bank of England promising us that inflation would fall – a promise they have been making continuously for the last 4 years – inflation rose even more, fuelled by their low interest policy and money printing, and its consequent policy of devaluing the pound, which has pushed up import prices for things such as fuel and food. Last month's fall in the inflation rate, which was largely technical due to the falling out of the calculation of last year's VAT rise, looks likely to be short lived, as oil is heading back up to record highs, and petrol prices are already at record highs. Now Interest Rates are rising too, whilst wages are frozen, and falling sharply in real terms, whilst house prices are beginning to collapse by up to 50%.

According to the BBC, Banks and Building Societies are set to raise Mortgage rates by a whacking 14%, from 3.5% to 4%. That will come as yet a further blow to a rapidly falling property market on top of the removal of the Stamp Duty holiday that has been in place. Already, as the property website Propertysnake is showing, even Asking prices for houses are being cut by as much as 50%. Propertysnake monitors changes in asking prices across the country. Its very useful, allowing you to put in a postcode, and see exactly how much prices are falling for actual houses in that area.

With wages frozen, benefits being cut, and rapidly rising inflation cutting into workers' living standards, its now wonder they have no money left to keep the huge property bubble inflated. With rising unemployment, and now sharply rising interest rates, all of the conditions are in place for a repeat of the collapse of the property market that occurred in 1990. But, this bubble is bigger, meaning the collapse will be bigger too.

Before the election, the Tories had promised to introduce a fuel price stabiliser that would cut fuel duty whenever the price of oil rose. Now with diesel prices already over 140p per litre, and headed for 150p, the Tories cannot cut fuel duty much further without risking blowing a hole in their Budget. There are several reasons for the rising price of oil. For one the world is probably at a stage of Peak Oil production, so with demand rising rapidly in China and other developing economies, Supply cannot rise fast enough to meet it. Secondly, as the interview on Fareed Zacharia with Ronen Bergman spelled out today, Israel is planning to launch a strike on Iran some time this year. With a developing Cold War by proxy in the Middle East, as western imperialism lines up behind the Sunni Feudal Monarchies of the Gulf, and their allies, and Russia and China line up behind Iran, Syria, and oppressed Shia populations in the Gulf Monarchies, such an event is likely to spark an extensive regional war at the very least, and something wider at worst. The fact, that clerical-fascist regimes have now come to power in Iraq, Egypt, Tunisia, Libya, and could well come to power in Syria and elsewhere, make the future even more uncertain. Even if the Straits of Hormuz did not get closed, such a conflict would mean that oil production and distribution in the region was severely curtailed. Under such conditions, the current price looks likely to be far from taking full account of the necessary risk premium. A serious dislocation would be likely to send Oil to anything between $200 and $400 a barrel. Thirdly, apart from those factors, the policy of the Bank of England over recent years of printing money has pushed up inflation in general, and by devaluing the pound has had a direct effect on increasing the price of imported oil.

On top of that, as I predicted a while ago, interest rates are now also rising, despite the policies of the Bank of England. That is because the interest rates charged by the Banks and Building Societies are more determined by what they have to pay in the money markets to borrow money. Over the last 6 months or so, those rates have been rising rapidly, because, as happened with the Credit Crunch of 2008, the Banks are now worried about their own financial health. The interbank rates that banks charge each other has soared, as banks worry that they might not get their money back, and scramble to boost their own cash holdings. When the ECB pumped out €500 billion in the Long Term Refinancing Operation (LTRO) at the end of last year, it helped ease that situation. Banks were able to offload some of their dodgy Bonds to the ECB, in return for cash at 1% interest rates. Its basically Money printing, and the ECB acting as lender of last resort by any other name.

The idea of the LTRO was that these banks would then use the money they borrowed to buy up the Bonds of their own Governments in what is termed a “Carry Trade”. That seemed to work to an extent as the Yields on Italian and Spanish Bonds fell, though they are hardly at low levels even now. They have just repeated the exercise. Over 800 Banks across Europe borrowed money. But, for the last few months, European Banks have also been depositing record amounts with the ECB itself overnight. The ECB points out that its not the same Banks who are depositing the money that are borrowing the money. The message from that seems clear. Of those 800 Banks, a large number seem to need the money to bolster their own liquidity and solvency. That also seems to be the analysis of the Credit Ratings Agencies, who continue to downgrade European Banks.

The other reason for that is that across Europe, and within the UK, many Banks are in a position similar to that of Japanese Banks in the 1990's, or US banks after the Sub Prime crisis. They are zombie banks. They have large amounts of loans outstanding on property that is listed at unrealistic prices. Once those property prices are rectified, once the loans of the Banks begin to be properly written down, many of those Banks will be seen to be bankrupt. Bloomberg had a story setting that out on Friday. They write,

“Investors view the 182 billion euros of bonds tied to Spanish residential-mortgage backed securities as being among the least creditworthy in Europe, trailing securities from the U.K., Netherlands and Italy. The outlook for the collateral is expected to worsen as mortgage arrears rise with increasing unemployment and house prices continue to fall, Moody’s Investors Service said in a report last month.”

As austerity across Europe causes these property prices to collapse, as well as causing economic activity to go back into recession, no amount of money printing by Central Banks will lead to higher borrowing to reflate these bubbles, and consequently, the Banks will go bust in large numbers. All the ECB has done is to buy Sovereign debt in Greece, Italy, Portugal, and Spain some temporary relief, but only at the cost of throwing the burden back on to the Banks.