Dead Men Left

Tuesday, August 02, 2005

Rates and circles

The Indy's really been going for it with the economic doom-mongering of late. Here they are on HSBC's reported rise in bad debt:

The banking giant HSBC has added to fears over worsening credit quality by unveiling a 20 per cent rise in provisions for bad debts worldwide, with the UK the worst hit. Yesterday's figures provided the latest evidence that the tough consumer market is hurting Britain's major banks...

The comments echoed those made by Lloyds TSB last week when it reported a 21 per cent jump in losses on retail loans to £416m. With big increases in bad debts expected from Britain's other major banks in coming days, the only bright spot this week looks to be the widely anticipated cut in interest rates on Thursday, which could provide some relief to hard-pressed consumers.

...except the cut in interest rates is a "two-edged" (?) sword:

The explosion in consumer debt to record levels has staved off a recession in the UK but may prove to be a poisoned chalice for the Bank of England when it comes to setting interest rates...

With the stock of debt bursting through £1 trillion (£1,000bn), the rate rises appear to have put the brakes on the economy more effectively than in the past.

As people borrow more, it makes sense for them to become more sensitive to interest rates. However, they might well be not just sensitive to rates now, but sensitive to rates in the future. There's a point at which interest rates become so low, they can only plausibly be expected to rise: people will borrow and spend huge amounts now, in the expectation that rates will rise again later. The trouble is, every time they do so, inflationary pressures increase; in response, the MPC whacks up interest rates. In the expectation that they will fall, borrowing and spending by consumers grinds to a halt. A vicious circle develops, with upswings and downswings in interest rates and rates of borrowing becoming more pronounced on each turn. At every cycle, however, the total stock of private debt is larger; the risk to the economy as a whole is greater; and the situation moves further beyond anyone's immediate control.