Does raising base rates really reduce inflation?

[Mike4]

And this is a feedback mechanism anyway. Energy prices rise, mopping up spending power in the same way as raising interest rates. No need to do both, surely.

Cart before the horse. Energy prices rise because there is consumer spending power. Interest rate rises drain the liquidity.

GS

Hardly. Energy prices rise (and fall) for reasons unconnected with consumer spending power.

Unlike most optional purchases.

[GoSeigen]

Cart before the horse. Energy prices rise because there is consumer spending power. Interest rate rises drain the liquidity.

GS

Hardly. Energy prices rise (and fall) for reasons unconnected with consumer spending power.

Unlike most optional purchases.

Not at all. If consumers couldn't pay the price would not rise.

GS

[Mike4]

Hardly. Energy prices rise (and fall) for reasons unconnected with consumer spending power.

Unlike most optional purchases.

Not at all. If consumers couldn't pay the price would not rise.

GS

So how come diesel prices are falling now?

[Tara]

With regard to the medium term interest rate outlook, a cold winter will see inflation increase with substantial increases in energy prices.

So, in my book raising or lowering interest rates over the next 9 months is irrelevant compared to what mother nature is going to do this winter.

And this is a feedback mechanism anyway. Energy prices rise, mopping up spending power in the same way as raising interest rates. No need to do both, surely.

Yes, there is a need to do both as UK consumers are still feeling “richer” because of ever rising UK house prices.

The BOE need to keep raising interest rates, and keep them raised for a sufficient length of time, until they strangle ever rising UK house prices. The BOE need to ensure that UK house prices fall quite a long way in real terms.

UK house price falls of 20% or 30% in real terms will probably be needed to get full control of UK inflation.

[dealtn]

And this is a feedback mechanism anyway. Energy prices rise, mopping up spending power in the same way as raising interest rates. No need to do both, surely.

Yes, there is a need to do both as UK consumers are still feeling “richer” because of ever rising UK house prices.

The BOE need to keep raising interest rates, and keep them raised for a sufficient length of time, until they strangle ever rising UK house prices.

That might be what you want, but it won't be happening for that reason. The MPC (again not the BoE!) will look at its mandate in deciding how it will address inflation (and its other secondary mandated objectives). To them house prices are only a minor factor in what they are doing, and why.

[Tara]

Yes, there is a need to do both as UK consumers are still feeling “richer” because of ever rising UK house prices.

The BOE need to keep raising interest rates, and keep them raised for a sufficient length of time, until they strangle ever rising UK house prices.

That might be what you want, but it won't be happening for that reason. The MPC (again not the BoE!) will look at its mandate in deciding how it will address inflation (and its other secondary mandated objectives). To them house prices are only a minor factor in what they are doing, and why.

The effect will still be the same though.

The higher interest rates, for a longer time, will bring UK house prices down by over 20% in real terms over the next few years.

[dealtn]

That might be what you want, but it won't be happening for that reason. The MPC (again not the BoE!) will look at its mandate in deciding how it will address inflation (and its other secondary mandated objectives). To them house prices are only a minor factor in what they are doing, and why.

The effect will still be the same though.

The higher interest rates, for a longer time, will bring UK house prices down by over 20% in real terms over the next few years.

The effect (and what you want) will only be the same if they "keep raising rates, and keep them raised for a sufficient length of time ..." which will only happen if it is appropriate for their mandate. If its not, and worse (from your perspective), their mandate requires them to cut rates, house prices could rise even in real terms. That won't concern them.

[Nimrod103]

Hardly. Energy prices rise (and fall) for reasons unconnected with consumer spending power.

Unlike most optional purchases.

Not at all. If consumers couldn't pay the price would not rise.

GS

Not often I agree with GS, but this must be correct. And if consumers can't pay the increased fuel prices, they buy less, and so the weighting of fuels in the inflation shopping basket have to be adjusted downwards. And thus calculated inflation begins to fall.

However, as it stands, consumers have been able to afford the rise in fuel prices,though clearly their buying power is now reducing and prices will come down. They are responding to the tightening money supply.

[Tara]

The effect will still be the same though.

The higher interest rates, for a longer time, will bring UK house prices down by over 20% in real terms over the next few years.

The effect (and what you want) will only be the same if they "keep raising rates, and keep them raised for a sufficient length of time ..." which will only happen if it is appropriate for their mandate. If its not, and worse (from your perspective), their mandate requires them to cut rates, house prices could rise even in real terms. That won't concern them.

It is of no concern to me whether UK house prices go up or down as I don’t live there. You obviously want them to keep going up though.

UK house prices have already fallen by 10% in real terms in the last year as UK house prices are now falling year on year, and inflation was about 10% in the last year. Another year of the same and UK house prices will have fallen by about 20% in real terms.

And so it will go on until UK house prices have fallen by about 30% in real terms.

[dealtn]

The effect (and what you want) will only be the same if they "keep raising rates, and keep them raised for a sufficient length of time ..." which will only happen if it is appropriate for their mandate. If its not, and worse (from your perspective), their mandate requires them to cut rates, house prices could rise even in real terms. That won't concern them.

It is of no concern to me whether UK house prices go up or down as I don’t live there. You obviously want them to keep going up though.

UK house prices have already fallen by 10% in real terms in the last year as UK house prices are now falling year on year, and inflation was about 10% in the last year. Another year of the same and UK house prices will have fallen by about 20% in real terms.

And so it will go on until UK house prices have fallen by about 30% in real terms.

I have no interest on whether they go up or not. Don't assume my position. if it is "obvious" then you have clearly misinterpreted it. My contribution is to correct your assertion on what the BoE (sic) "will" do, and what "will" happen to (real) house prices.

[1nvest]

The higher interest rates, for a longer time, will bring UK house prices down by over 20% in real terms over the next few years.

In the 1970's, when inflation spiked to 25% levels, real house prices did decline 33% in total over a few years, but then recouped those losses as high double digit interest rates declined back down again along with inflation. The real declines didn't get started until inflation and interest rates were into double digits. In the lead up to those declines as interest rates rose from mid single to double digits, house prices rose in real terms quite significantly.

A large proportion of houses are owned outright and owners will tend to defer selling at 'lower' prices, just sit tight/defer plans, or maybe up-size if a larger house owner is selling at a 'low', or even add additional properties as they're seen as a inflation hedge, rather than leaving cash in deposit accounts maybe earning 15% and paying tax on that when inflation is running at 20%+. We fall into that category, and if house prices did drop our investment plan/asset allocation would tend to have us selling gold and/or stocks to add a (mortgage free) property.

[Mike4]

That might be what you want, but it won't be happening for that reason. The MPC (again not the BoE!) will look at its mandate in deciding how it will address inflation (and its other secondary mandated objectives). To them house prices are only a minor factor in what they are doing, and why.

The effect will still be the same though.

The higher interest rates, for a longer time, will bring UK house prices down by over 20% in real terms over the next few years.

I think you're right, but you do seem fixated on a need for 20% falls across the board.

Where does this figure come from and how will it help?

I get the feeling you are too young to remember when house prices were 20% of what they are now (20% of, not 20% lower), and people were still saying the same, that houses were overpriced and a crash was just around the corner.

[ursaminortaur]

Not at all. If consumers couldn't pay the price would not rise.

GS

Not often I agree with GS, but this must be correct. And if consumers can't pay the increased fuel prices, they buy less, and so the weighting of fuels in the inflation shopping basket have to be adjusted downwards. And thus calculated inflation begins to fall.

However, as it stands, consumers have been able to afford the rise in fuel prices,though clearly their buying power is now reducing and prices will come down. They are responding to the tightening money supply.

The energy prices we pay are the world market prices. If UK consumers can't pay them then it will barely effect prices as other countries and their citizens will pay those prices for the limited supply. Tightening money supply/raising interest rates just hurts the ability of UK consumers to buy - but then capping the price at the same time blunts the effect of that. ( And any indirect effect of raising interest rates affecting exchange rates is rendered ineffectual since other countries are also raising interest rates ).

[Tara]

The effect will still be the same though.

The higher interest rates, for a longer time, will bring UK house prices down by over 20% in real terms over the next few years.

I think you're right, but you do seem fixated on a need for 20% falls across the board.

Where does this figure come from and how will it help?

I get the feeling you are too young to remember when house prices were 20% of what they are now (20% of, not 20% lower), and people were still saying the same, that houses were overpriced and a crash was just around the corner.

Not correct. I can easily remember when UK house prices were 20% of what they are now. I can also remember when they were about 10% of what they are now.

The need for a 20% fall in UK house prices is not a fixation, but it needs to be a large enough fall in real terms to bring the house price multiple of average earnings back to its long term trend of about 4x average earnings. At present this UK house price multiple is at an absurd level of between 8x or 10x average earnings depending on what figures are used.

So, a fall in UK house prices of about 20% in real terms will actually not even reverse the huge rise in UK house prices since Covid, and it would only reduce the UK house price multiple of average earnings to about 6x or 7x average earnings.

A fall in UK house prices of about 40% in real terms over the next few years will be needed to bring the multiple back to a more reasonable 4x or 5x average earnings.

[Mike4]

I think you're right, but you do seem fixated on a need for 20% falls across the board.

Where does this figure come from and how will it help?

I get the feeling you are too young to remember when house prices were 20% of what they are now (20% of, not 20% lower), and people were still saying the same, that houses were overpriced and a crash was just around the corner.

Not correct. I can easily remember when UK house prices were 20% of what they are now. I can also remember when they were about 10% of what they are now.

The need for a 20% fall in UK house prices is not a fixation, but it needs to be a large enough fall in real terms to bring the house price multiple of average earnings back to its long term trend of about 4x average earnings. At present this UK house price multiple is at an absurd level of between 8x or 10x average earnings depending on what figures are used.

So, a fall in UK house prices of about 20% in real terms will actually not even reverse the huge rise in UK house prices since Covid, and it would only reduce the UK house price multiple of average earnings to about 6x or 7x average earnings.

A fall in UK house prices of about 40% in real terms over the next few years will be needed to bring the multiple back to a more reasonable 4x or 5x average earnings.

Thanks for explaining.

I think when interest rates return to the levels they were when the average house was 4x average earnings, your wish will be granted.

First time buyers however, don't generally buy 'average' houses. They buy starter homes and similar, generally. Nor do they earn average salaries.

[Alaric]

A fall in UK house prices of about 40% in real terms over the next few years will be needed to bring the multiple back to a more reasonable 4x or 5x average earnings.

Between, say, 1989 and 1992 prices dropped by something like 25% to 30% in money terms and didn't start moving again until New Labour after 1997. Personally I think the mandate for managing interest rates and inflation given to the Bankk of England missed a trick. Namely it should also have targeted inflation in the price of land and housing with a view to keeping the relationships between age, salary and house purchase affordability at a consistent level. But perhaps the perceived need to cut interest rates towards zero following the banking crises of 2007-2008 would have scuppered this.

[Eboli]

Lootman noted:

The Marylebone Ivy restaurant used to require reservations every day, but now has a sign outside saying that it is accepting walk-in's - something that they never needed to do before.

London hotel rates are still high but have stopped going up - a decent 4-star place is 200 quid a night mostly - not low but not terrible. And they have rooms at short notice.

Thanks for that which suggests under the gold sovereign night out test that prices are just a little under the long term trend (cost of London hotel room (£200) + cost of meal at the Ivy cafe without alcohol (about £60) + cost of mid price ticket for London show (my last one at ENO cost £115) = £375 and that's about £15 above the gold value in a sovereign at present.

Eb.

[1nvest]

A fall in UK house prices of about 40% in real terms over the next few years will be needed to bring the multiple back to a more reasonable 4x or 5x average earnings.

Between, say, 1989 and 1992 prices dropped by something like 25% to 30% in money terms and didn't start moving again until New Labour after 1997. Personally I think the mandate for managing interest rates and inflation given to the Bank of England missed a trick. Namely it should also have targeted inflation in the price of land and housing with a view to keeping the relationships between age, salary and house purchase affordability at a consistent level. But perhaps the perceived need to cut interest rates towards zero following the banking crises of 2007-2008 would have scuppered this.

1985 to 1988 inclusive and house prices rose 85% in RPI real terms. The subsequent dip to 1992 lows (drawdown of around 37%) still had prices around 20% higher in real terms than 1985. Took until the late 1990's to recoup the RPI real level of the 1988 highs. i.e. was a bubble, that periodically occur in all assets, Japan stocks 1990, US Roaring 20's (1929 highs) ...etc. If/when assets gain 'too much too quickly' then subsequently that tends to be corrected.

[vand]

To answer OP: Yes. Tighter monetary conditions - which is effectively what higher (real) interest rates represent - have a definite effect on consumer price inflation, but the transmission mechanisms are not well understood even amongst many financially savvy people, but they are also quite crude and incredibly laggy thus easy to conflate with other factors.

Unfortunately human nature tends to only see what it wants to see. Inflationary booms are always driven by too loose monetary policy, but this is rarely acknowledged. People want the good stuff but can't take the other side of it.

[Laughton]

In depth analysis from an American perspective. Worth a read:- https://www.lynalden.com/inflation-vs-interest-rates/