by Philip Pilkington
Tuesday, 22
November 2022
Analysis
13:15

The OBR is hiding a future mortgage crisis

The public body's dubious modelling is concealing a darker truth
by Philip Pilkington
Credit: Getty.

Last week the Office of Budget Responsibility (OBR) released its November Economic and Fiscal Outlook. The new forecasts got particular attention because they accompanied the Chancellor’s Autumn Statement. The OBR forecasts generated some scary headlines, with the papers focusing on the grim figure for household disposable income that the OBR said would fall some 7% in the next two years.

Yet both the budget and the forecasts weren’t really that concerning. It appears that both the Treasury and the OBR pulled off an impressive public relations trick: they managed to convince the average Briton that the situation was bad, but at the same time they released a budget and forecasts that were less doom-mongering. Most importantly, they appear to have buried from view some of the worst economic consequences facing the British people.

The most striking of these is the potential mortgage crisis. Mortgage interest rates have seen some of their most rapid increases in history. Current forecasts suggest that the rate on the best fixed rate two-year mortgage will be around 6% by the end of 2023. This has a lot of people worried, and rightly so.

Housing in the United Kingdom is extortionately expensive, especially for first-time buyers. The best way to measure this is with a house price to income ratio (HPI). The HPI shows how much the average British house costs relative to the average income earned in the country. Currently, house prices are roughly seven times earnings. This is up from around five times earnings in 2013 and way up from around three times earnings in the mid-1990s.

With house prices so high relative to income, people must borrow a lot relative to their income. This is only affordable for the average Briton due to the extremely low interest rates that we have seen in recent years. Now that these rates are rising, the game has changed dramatically and housing at current prices no longer looks remotely possible for many.

The OBR ignores this, however. In its forecasts, it argues that rising interest rates “have little net impact on aggregate” household disposable income because while “other interest costs rise […] higher interest rates also boost interest income on household savings”. This is laughable. The OBR are saying that because some people — mostly older savers — are earning higher interest rates on their savings, this offsets the huge income losses for borrowers as their mortgage payments increase.

However, borrowers are going to get squeezed hard. Non-political entities recognise this. Fitch Ratings, for example, has done some excellent estimates on how much 6% interest rates would cost mortgage borrowers. Fitch estimates that for a representative borrower earning a gross income of £50,000 a year with a loan-to-income ratio of 4.5x, a 2.5% mortgage refinanced to 6% would raise monthly mortgage payments from around £1,000 to £1,450.

After tax, a person on £50,000 a year receives an income of around £37,500 a year, or £3,125 a month. After their mortgage this person now has around £1,675 to spend, while before interest rate hikes they had roughly £2,125. At the same time, they are expected to pay higher energy costs and face the cost of goods rising at over 10% a year.

If the OBR cannot see that this situation is introducing a very high risk of a mortgage crisis, they should realise that the forecasting game isn’t for them.

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R Wright
R Wright
9 days ago

This article is predicated on the nonsensical assumption that they don’t know exactly what they are doing. This is not ignorance, it is deception.

Graeme Creffield
Graeme Creffield
8 days ago
Reply to  R Wright

The evidence strongly suggests that they don’t know what they are doing. For example, a year ago they said “Over the remainder of 2021 and 2022, we expect CPI inflation to remain a little below the MPC’s 2 per cent target, as the rise in unemployment dampens wage growth, outweighing the effects of higher oil prices. Thereafter, CPI inflation rises gradually back to target by 2025 as the economy recovers.”

Mike Cook
Mike Cook
8 days ago

and no mention of the not inconsiderable cost of Net Zero

Peter B
Peter B
8 days ago

The other point overlooked in the simplistic modelling [by the likes of the OBR] here is that taking a larger loan for a more expensive house means a higher repayment. So higher house prices combined with higher interest rates both act to reduce disposable income (as does general inflation). This problem has been building up for at least 25 years and it’s not going to quietly self-correct.

Billy Bob
Billy Bob
8 days ago
Reply to  Peter B

If the idea of raising interest rates to curb inflation is that it does so by taking money out of general circulation, wouldn’t tax rises achieve the same effect? Why can’t the government simply raise tax rates and use the money to shrink the deficit instead of handing that money over to the banks?

John Riordan
John Riordan
8 days ago
Reply to  Billy Bob

In either case, what annoys me about these policy-level discussions is that they are conducted without ever mentioning the colossal human costs. Whether it’s rising rates or rising taxes, the effect is that inflation is curbed by making millions of working, earning people poorer, and a significant chunk of them actually unemployed.

It reminds me a little of some of the medieval treatments for diseases which did little except to kill both the patient and the disease in the faint hope that the patient might last just a little longer than the disease and consequently effect a cure.

We seem still to be in economic dark ages where monetary policy is concerned. There is a better way to control inflation, and it’s simply to produce more from the same amount ofm human effort. I say “simply” but of course nobody actually knows yet how to produce such an outcome through deliberate policy: it is always something that is recognised to have occurred in retrospect by policymakers, usually accompanied by sighs of relief and then attempts to claim the credit for it.

But we do know that certain factors are essential for it to occur: innovation, whether it’s obvious in the form of new inventions, or the more pedestrian variety in which constant effort by entrepreneurs finds more efficient ways to utilise existing resources – this is what increases productivity. We just have no control – as yet at least – over the size and timing of the longed-for benefits this brings.

You would think, however, that even allowing for this, policymakers would at least avoid onerous taxation policy that makes innovators think twice about investing their time and money in this way. Alas, we seem now to have people in charge who think that subjecting millions of mortgage payers and taxpayers to economic torture is something that they can debate openly as if it’s a purely abstract exercise. Personally, I suspect we’d get better performance from our government if we just fired half of them so that they had fewer people to cross-check their ideas with and just let markets decide how good they are.

Last edited 8 days ago by John Riordan
Brendan O'Leary
Brendan O'Leary
8 days ago
Reply to  John Riordan

Innovation and productivity are indeed the keys. Government is incapable of either. They can only regulate and obstruct to a greater or lesser degree.
As we have seen around the world with lockdowns, closing enterprise down was executed quickly and totally by governments. That’s their competency. Creating enterprise isn’t.

Dougie Undersub
Dougie Undersub
7 days ago
Reply to  Billy Bob

Because Gordon Brown, the gift that keeps on giving, gave the Bank independence and sole control of interest rates.

Ethniciodo Rodenydo
Ethniciodo Rodenydo
8 days ago
Reply to  Peter B

There is no mention of a property price crash which must e a potential outcome

Brian Villanueva
Brian Villanueva
8 days ago

There are 2 other things going on here:
1) Prior to COVID, price was inversely related to urban geographical proximity. The work-from-home boom altered that, allowing more distant properties to appreciate significantly. Hence, higher median home price nationally.

2) There’s some evidence that home prices were simply more responsive to COVID inflationary pressures than other assets. Other durable assets like cars shot up a year ago. Broad inflation appeared about 9 months ago. Wages are starting to show an increase now.
In other words, this will likely solve itself as mortgage rates rise and wages adjust to inflation.

polidori redux
polidori redux
8 days ago

“If the OBR cannot see that this situation is introducing a very high risk of a mortgage crisis, they should realise that the forecasting game isn’t for them.”
The OBR is a political organisation.