What can rising interest rates mean for different generations? – Institute of Tax Studies


Earlier this week, markets reacted to comments by the Governor of the Bank of England by advancing their expectations of when interest rates will rise. The discount rate is currently at an ultra-low level of 0.1% and has not exceeded 1% since January 2009, but markets are now anticipating an increase at next month’s MPC meeting and s’ expect rates to hit 1% by next summer.

It remains uncertain when the rate hikes will arrive, and they will likely be gradual when they do. However, questions arise as to the effects that rising rates would have on the economic prospects of different generations. This observation highlights that the outlook for interest rate hikes over the past 18 months is modest in the context of the declines seen over the past 15 years and expectations are that interest rates will remain low for years to come. future. The main effects of the rate hike are likely to be an increase in mortgage payments for working-age people in the short term, and the effects on asset prices relative to incomes are likely to be modest compared to the large increases seen over the years. decades.

Impact on interest income and debt repayments

The most obvious and immediate impacts of an increase in interest rates are manifested in its effects on income from interest-bearing accounts and on the repayments of debts – such as mortgages and credit cards – with interest rates. of variable interest. A change in interest rates will not necessarily have an immediate or full impact on a change in the interest paid on savings accounts and in the interest rates on loans. For example, a growing share of new mortgages taken out in recent years have fixed rates for five years or more. Nonetheless, we do get some idea of ​​which age groups to gain or lose from the impacts of a rate hike on interest income and debt repayments by looking at the amount of their debts (including mortgages, loans, etc.). unsecured and credit card balances) against their interest-bearing assets (including current accounts, savings accounts, treasury ISAs, and national savings and investment products).

Figure 1.1 shows the percentage of people living in a household with debts (excluding student loans with a fixed interest rate or linked to the RPI) greater than their interest-bearing assets, broken down by age group. This share increases by about half of people in their twenties to peak at 70% of those in their late thirties and early forties, before decreasing with age. This trend is because people take on debt – including mortgages when they buy a home – as they move into their 20s and 30s and then pay it off as they get older. , while the accumulation of interest-bearing assets increases with age, especially for older people. than 50.

Figure 1.1 also shows the 25e percentile, 50e percentile and 75e percentile of the distribution of household net remunerated assets (that is, remunerated assets minus debt) as a percentage of annual income. The age structure of debt and asset holding means that while the median individual in their late 30s or early 40s is in a household with net interest debt worth more than annual income, the median person in their late sixties and sixties has net household interest income assets 70% or more of annual income. The differences within age groups are significant: while 30% of people in their early 40s have net interest-bearing assets, a quarter have net debt – mostly mortgages – worth more than three. times the annual income.

This means that, on average, people in their 30s and 40s lose the most, and those near retirement, the most, from the short-term impact of rising interest rates on income. interest and debt repayment. However, the differences in the generations are also large.

Chart 1.1. Breakdown of net interest-bearing assets of households as a multiple of annual income (LHS) and percentage of individuals in households with negative net interest-bearing assets (RHS), by age group

Source: author’s calculations using the Wealth and Assets Round 6 survey (2016-2018)

Note: Interest-bearing assets are the sum of current accounts, savings accounts, cash ISAs, domestic savings and investment products, net of mortgages, formal unsecured loans (at the excluding student loans) and credit card balances.

Impact on asset prices

What about the broader impacts of rising interest rates on asset prices? Research by the Bank of England found that the fall in interest rates following the financial crisis pushed up asset prices and that this had the most positive effect on the wealth of people near their retirement age. pension, who hold the largest amounts of financial assets, real estate and pensions not converted into annuities. A rise in asset prices, if sustained, implies a gain for those who hold those assets and sell them in the future, and a loss for those who would buy them.

Does this mean that a rate hike will decrease the value of financial assets and real estate, affecting the wealth of people close to retirement age the most? Would a drop in asset prices be welcome for younger people who aspire to enter or climb the real estate ladder?

The price of assets such as houses, stocks, and stocks does not only depend on current interest rates, but on the medium-term rate outlook. Figure 1.2 shows that there has been a significant increase in future interest rates implied by government bond yields since April 2020, when the pandemic began, especially at shorter time horizons. However, these increases are actually modest compared to the huge drop in rates that has taken place since 2006.

Chart 1.2. Instantaneous forward curve for government gilts

Chart 1.2.  Instantaneous forward curve for government giltsSource: Bank of England

In addition, the yields of indexed gilts, which explain the expected inflation, have increased less in recent months. In fact, at over 13 years of age, the interest rates implied by the real return on indexed gilts are now lower than in April 2020. This implies that the higher nominal bond yields are largely a response to expectations. inflation, which means a smaller rise, or even a fall, in real interest rates (after inflation) expected over the medium term. This higher inflation will help erode the real value of mortgage debt for young people who already own a home. But modest changes in real interest rates don’t mean a big change in circumstances for those looking to buy.

Overall, while the policy rate is now expected to rise, the medium-term outlook for real interest rates has seen only very small changes from the sharp interest rate cuts of recent decades. This means that we are far from seeing the outcome of the significant increases in asset prices relative to income that have taken place over the past few decades and are likely a key factor in the plummeting homeownership rates of people in their 20s and 30s. For younger generations, this means that accumulating wealth in the future is likely to be more difficult than for previous generations and potentially more dependent on receiving transfers from wealthy parents.

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