Interest rate reduction fails to lift households out of debt

16th December 2010

However, a number of recent surveys have found that low interest rates may not be having the impact on household wealth that policymakers had intended.

This piece in the Telegraph cites a survey by NMG Financial Services that suggests that low interest rates have not been as beneficial for households as they might have been because so many have their debts concentrated on credit cards. These have been stubbornly resistant to reductions in interest rates and have – on average – risen from 17.8% in November 2007 to 18.7% today.

This Daily Mail story highlights the same phenomenon: "More than a quarter of households are struggling to pay their credit card bills as banks continue to wring as much as they can from hard-pressed families, a report from the Bank of England reveals today."

Those who – by luck or design – have avoided these debt problems are vocal on the boards: Anthony says on the Daily Mail site: "I cut up my credit cards years ago. There is no need for them these days. My bank debit card works as a visa card, but removes the money from my bank account immediately. This makes me more careful with my spending and prevents debts from growing."

That's great for Anthony, but not so good for the wider economy. This Youtube clip from Sky offers a stark reminder of the debt burden facing the UK. If it is not being addressed through lower rates – how are people going to deleverage?

In all the noise surrounding the government's debt burden, it' easy to forget that there is a huge personal debt burden to unwind as well. Mortgage rates have come down, but not everyone has been able to participate as lenders have scaled back mortgage availability and tightened lending criteria. Others may be on longer-term fixed rate mortgages from which they cannot exit.

This article from last year shows the profound impact of deleveraging and how far the US economy has to come. The UK is labouring under a similar burden. Fund managers in the UK have predicted that the deleveraging cycle could last until 2015. It will act as a potential headwind for the UK economy in the meantime.

However, there is something to be taken from this: If interest rate falls are not feeding through to households' bottom line, then interest rate rises might not be as catastrophic for the wider economy as expected. As such, the question of whether inflation is the price of recovery may not be as stark as originally thought.

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