BNY Mellon’s Geoff Yu: Rate hikes in Europe and UK may be the wrong option

by | Jul 13, 2023

With household spending and inflation across the Eurozone and UK remaining stubbornly high, Geoff Yu, FX and Macro Strategist for EMEA, BNY Mellon, questions if rate hikes are the answer to curb a potential wage-price spiral.

He said: “Perhaps much to the frustration of policymakers around the world, households across developed markets are simply not reacting to monetary tightening. The demand is most likely supporting labour markets in services, which in turn is further driving up spending power and contributing to the prospect of a wage-price spiral. While the latest round of PMIs and other business surveys continue to show soft data rolling over, hard data is holding firm – leaving policymakers at a loss to explain the disconnect. The longer this situation holds, the more we expect markets to question the credibility of interest-rate-based tightening. Already, key decisionmakers in some quarters are floating the prospect of accelerating balance sheet roll-offs. The phrase “if it isn’t hurting, it isn’t working” is being used more often in the UK now with respect to monetary policy. Policymakers and finance ministries may urgently need to look at what can truly “hurt” the household on a broader basis. Perhaps it’s not that interest rates are not sufficiently high, but instead that rate hikes are simply the wrong option.

“European core inflation figures are robust, but a unique trend in recent months has been concentrated gains in specific areas. Particularly in Sweden and the UK, it is on the experiences side (notably spending associated with live events) which is driving the upside surprises – clearly a sign of robust services demand. There is a similar trend of acceleration or consistently strong prints in the UK and Eurozone. Into the summer months when such spending is typically the strongest, a slowdown in demand for ‘experiences’ is highly unlikely. Ceterus paribus, core inflation seems set to remain high.

“Interest-rate increases are designed to erode disposable income through raising debt-servicing costs. Perhaps aware that excess savings would generate commensurate levels of excess demand once society normalised, rate hikes were deployed – but in hindsight lacking urgency or strength. The multiplier effects of demand and labour shortages have also generated income growth which is strongly nullifying the effect of interest-rate rises, especially as the latter is the main point of transmission for household debt servicing. Nowhere does this seem more acute than in the UK. 

“The BoE’s latest Financial Stability Report broadly confirms the lack of impact: the BoE estimated that the “typical” mortgage holder would face a £220/month payment rise. Matched against the £32,300 median household disposable income in the financial year ending 2022, in nominal terms that represents an increase of around 8% of HDI. However, wage growth alone is running at close to 7%, and coupled with higher remuneration on savings, it is not hard to anticipate UK mortgage outlays being fully offset by the growth in augmented HDI. 

“In the context of debt servicing, the biggest risks will likely be in those economies where household debt – especially in mortgages – was low in the first place. As shown below, Germany’s household debt-service ratio had no reaction to 250bp in tightening over six months in 2022 (with an even larger increase in swap rates). Furthermore, savings have been traditionally high and sticky in Germany, which means that the impact of interest payments on augmented household disposable income would be stronger than peers. 

“After last year’s mistakes, global policymakers will likely need to err on the side of caution and not view behavioural changes as transitory. As ever, it means that if there is any moment for the core Eurozone’s supposed fiscal frugality to show, it may well be now.”

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