Surging inflation poses tough choices for wealthy borrowers

Inflation surged past the Bank of England’s target for the first time in almost two years last month. That leaves borrowers with choices to make, says Alex Ogario, Head of our Private Office.

Think of an object, any object, and the price is probably rising.

Whether you chose second hand cars, any of the building materials, or anything in the consumer goods indexes, spanning from soap to sneakers, signs of inflationary pressures are everywhere. All that is left to debate is how far central bankers will let it go and for how long.

The consumer price index, the UK’s best measure of inflation, hit 2.1% in the year to May, the highest reading since July 2019. That’s likely to rise further as consumer spending picks up amid the reopening of the economy. The Bank of England, which seeks to hold the inflation rate at 2%, maintains this is a temporary surge that will right itself when imbalances in supply and demand correct, but some – including his own chief economist Andy Haldane – appear unsure.

The current Bank of England forecast is that inflation will hit 2.5% by the end of this year, before slowly falling.

The Bank isn’t alone in delivering this message. Supply chain imbalances are a truly global issue, and the UK’s surge in inflation looks decidedly modest compared to some other developed economies. In the US, for example, consumer prices are soaring faster than any time since 2008.

Whether that will play out as the officials expect is at the forefront of the minds of our wealthy clients, many of whom have enjoyed variable mortgage rates at close to record lows for several years. That’s enabled them to take on cheap mortgage debt in order to allocate capital to both property and other assets classes. Huge fiscal stimulus issued by governments seeking to steady economies during the worst of the pandemic has fuelled a boom in the price of those assets and fortunes have swelled.

But times are changing. Swap rates – the best measure of how the market perceives the path of interest rates – are trending upwards. Markets are now betting interest rates will begin to rise early next year and some of the largest private banks that we work closely with are already building rate rises into their behaviour, notching up the price of their products.

Many wealthy clients have asked me in recent weeks whether now is the right time to scrap their variable rate in order to fix. The answer must be a judgement call as to whether you believe the Bank of England will hold its nerve. Swap rates influence the cost of fixed rate mortgages, and it’s reasonable to assume that without any major changes to our economic fortunes the path is upwards.

Variable rate products, on the other hand, are often pegged to the base rate. If the Bank does what it says and supply chain imbalances do indeed right themselves as officials predict, borrowers that stick on a variable rate can save a considerable amount of money. Smart voices, including US investment bank JP Morgan, even suggest that, due to slowing population growth, ultra-low rates may become a permanent fixture of the new global economy.

We’ll know more when we see the minutes for the June meeting of the Bank’s Monetary Policy Committee. That report should offer fascinating insights as to what officials think might happen next.

Those that choose to wait before deciding should beware. The cost of almost everything is rising, and for now that includes fixed rate mortgages with the top private lenders.