View the article online at http://citywire.co.uk/money/article/a518879
Inflation: a stealth tax to torture savers
First time buyers are losing all hope as houses remain unaffordable and low interest rates plus high inflation makes saving for a deposit impossible.
It’s a full four years since the property market peaked. A credit crunch and a debt crisis were meant to have shone a flashlight on a market caught with its pants down: not the faithful, reliable lover we’d taken for granted, but something doing the dirty on us all along.
And yet even the details of unsafe lending and artificially inflated prices weren’t enough to precipitate a proper 'correction'. Houses remain, by most measures, unaffordable.
First time buyers are losing all hope
According to new figures from the Post Office, 53% of potential first-time buyers have lost all faith in their ability to ever buy a home. Among the optimist minority, 35 is the age at which they think they’ll be financially prepared to invest. Back in the 1960s, if you were the house-buying type then you expected to be greeted by an amiable bank manager when you were 23, your house following not too long after your first pair of winkle-pickers.
So what are the powers-that-be doing to help? Interest rates have remained low, certainly, but that hasn’t done much to help savers trying to put together a deposit. And the associated higher inflation is making it harder to save in the first place. There’s the government’s FirstBuy scheme, targeting an underwhelming 10,000 buyers and flawed from the outset by its cozy relationship with the developers (the Wolf, not the Grandma, as far as first-time buyers are concerned).
But as the Monetary Policy Committee consistently fails to tackle inflation, turning a blind eye to an overshot target in 26 of the last 40 months, you’d be forgiven for wondering whether this lack of attention isn’t so flagrant that it has to be a plan in disguise. What if inflation isn’t a mistake, but a policy?
If so, it’s a cruel one. The combination of low interest rates and high inflation means slow torture for savers, who get to see their cash diminishing in terms of both reward and spending power.
Inflation as a policy
Behind the scenes and from a government perspective, the country, however, might not do so badly. During periods of high inflation, the substantial compound interest losses suffered by savers become very real gains when trying to reduce a national debt burden. In simple terms, the size of the debt is – behind the scenes – diminishing all the time, taking a few sharp edges off the cuts and working, to a degree, like a stealth tax.
It’s been done before, but it works better in some environments than others and remains far from uncontentious. Falling living standards, associated with inflation, can impact government debt by increasing the welfare spend. Gilts linked to inflation will need to be serviced at a higher level, but taxes on lagging earnings won’t provide the shortfall. And yet there are cleverer commentators than me who seem to have fallen in love with the idea of suffering sterling.
Extreme caution is advised, however, when attempting to apply the theory to individual borrowers. The only time inflation helps pay off a mortgage is when earnings are keeping pace with prices. They’re not.
Fingers crossed for the future
Except… first-time buyers might, in the medium to long term, welcome inflation.
It’s another indication of just how sick the UK property market is that what was once considered a safe hedge against inflation is currently (depending on your choice of index) underperforming by around 15%. According to the National Institute of Economic and Social Research, it’s a trend that will continue for some time, knocking a further 10% off house prices over the next five years. Nominal values, as reported by the leading house price indices, will remain fairly static, perhaps even rise a little; but this could turn out to be an inflation-led correction.
The message to determined first-time buyers is: continue to save for a deposit – even if returns on savings accounts are hard to get excited about – because a deposit isn’t something that can be created in a hurry. And hope that rising earnings in around five years’ time will combine with stalled prices to create a significantly healthier buying environment.
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by Daniel Grote on Sep 03, 2015 at 15:04