Interest Rate Surge Delivers Record Biggest Wealth Fall For British Households Since World War II

17th July 2023

Rising interest rates have caused household wealth across Britain to fall by £2.1 trillion over the past year, but there are winners - concentrated among younger generations - as well as losers if higher rates are sustained, according to major new analysis published today (Monday 17 July 2023).

The report Peaked Interest? - part of a partnership with the abrdn Financial Fairness Trust - examines the impact of rising interest rates on household wealth, and what a ‘new normal' of higher rates could mean for living standards and wealth accumulation in the future.

The report notes that Britain has experienced an unprecedented wealth boom in recent decades, with total household wealth rising from around 300 per cent of national income in the 1980s, to 840 per cent - or £17.5 trillion - by 2021.

However, the Bank of England's rapid rate-rising cycle since late 2021 has caused mortgage rates to rise, house prices to fall and, critically, the price of government and corporate bonds to plummet.

Falling bond prices have reduced the measured value of pension assets (largely in DB schemes, or already in payment), normally the biggest single source of household wealth in Britain. The Foundation's estimates suggest total household wealth has fallen to 650 per cent of national income in early 2023 - a cash fall of £2.1 trillion over the past year and the biggest fall as a share of GDP since World War II.

If higher rates remain (markets currently expect Bank of England policy rates to still be at 5.5 per cent in mid-2025), it could drive further falls in wealth to around 550 per cent of GDP. This would end the 40-year wealth boom that has been a key driver of intergenerational inequality - with surging house prices and pension values largely benefiting older generations at the expense of young people, many of whom have been locked out of home ownership altogether.

The Foundation's analysis shows that persistently higher interest rates would have two key long-term effects - lowering house prices and making it easier to achieve a decent standard of living in retirement by raising rates of return on pension savings.

Higher interest rates could reduce the house-price-to-earnings ratio from its 2022 peak of 8.9 to 5.6, a level not seen since the turn of the century. Were this adjustment to happen over five years, it would mean house price falls of around 25 per cent in cash terms.

Although rising rates are causing a crunch for mortgagors – the 1.7 million households re-mortgaging next year are set to see their annual repayments rise by over £3,000 on average – falling house prices will benefit prospective house-buyers.

First, it will reduce the deposit barrier for first-time buyers. Back in the mid-1990s, it would have taken a typical young, first-time buyer couple around eight years to save for a ten per cent deposit on an average first-time home. This figure has risen to 14 years today, but could fall back to around ten years in this lower-wealth scenario.

Second, while rising rates add to the cost of repaying mortgages, this would be more than offset by the lower mortgage principal needed to purchase the house, thus reducing the overall lifetime cost of property ownership for new buyers.

On pensions, the Foundation notes that in the pre-pandemic world, a typical worker would need to save around £5,000 a year to achieve an income in retirement worth two-thirds of their income prior to retiring. Under today's higher interest rates, the same worker would need to save around £3,000 to achieve that same standard of living in retirement – making it easier for younger cohorts to save sufficiently to enjoy decent living standards in old age.

The authors caution that millions of people are still under-saving for their retirement, and that minimum contribution rates into pension schemes will still need to rise, but by far less than in a low-interest-rate world.

Of course, the current rate-rising cycle could be a blip in an ongoing long-term trend towards lower interest rates. In such a scenario, wealth would continue rising – reaching ten times national income in the longer term and reinforce, rather than reverse, some of the generational strains Britain has seen build up over recent decades.

Ian Mulheirn, Research Associate at the Resolution Foundation, said, "Over the past four decades wealth has soared across Britain, even when wages and incomes have stagnated. But rapid interest-rate rises have ended this boom and brought about the biggest fall in wealth since the war, of £2.1 trillion.

"Those with significant mortgages will be hit by these major changes. But there are winners too from a shift to a world of higher rates and lower wealth. Higher returns will make it far easier for younger people to save for a pension that delivers a decent standard of living in retirement, while lower house prices will make it easier for younger generations to get on the property ladder and others looking to trade up.

"The future path of interest rates is very uncertain. The current surge could be a blip, or herald a new era for the UK. Either way, policy makers should focus more on whether and how to insulate households from wild swings in their fortunes from these forces well beyond their control."

Mubin Haq, CEO of abrdn Financial Fairness Trust, said, "The short-term pain of higher interest rates for mortgage holders could also mean a longer-term gain for young people hoping to buy their own homes and saving for their pensions. Both become more affordable and allow for a fairer sharing of wealth. In these turbulent times, when assets have tended to held by older generations, we may see rising interest rates reversing the growth in wealth gaps Britain has seen over recent decades."

Peaked Interest?
What higher interest rates mean for the size and distribution of UK household wealth.

Over the past four decades, the total value of wealth owned by UK households has been on a seemingly-relentless upward path: rising from around three-times GDP in the mid 1980s to almost eight-times. The key driver of this rise in wealth has been falling interest rates and the associated increase in asset prices. But the cost of living crisis has thrown this upward march into reverse as interest have risen sharply in response to the highest inflation in 40 years.

In this report we explore the impact of both changes in households' active saving behaviour, as well as ‘passive' moves driven by the sudden end to ultra-low interest rates, on the composition and distribution of household wealth. In addition, we discuss how policy makers should think about how to respond to seismic changes in the level – and volatility – of interest rates.

Key findings]/b]
Household saving has whipsawed over the past three years. The adjusted saving ratio peaked during the pandemic at 24.4 per cent – the highest on record. Saving has declined since but remains above its pre-pandemic level.

Saving behaviour has direct implications for household wealth holdings, but the fluctuations in interest rates have had a more profound impact: the pandemic saw interest rates hit record lows and asset prices boom which pushed the value of wealth to a peak of 840 per cent of GDP in early 2021.

The cost of living crisis, coupled with the monetary policy response, has put an end to the trend of rising wealth. Our estimates suggest that the wealth-to-GDP ratio fell to around 650 per cent by early 2023. This is by far the biggest fall on record as a proportion of GDP, wiping out £2.1 trillion of household net worth in cash terms.

A higher-rates world and an ultra-low rates world represent starkly different societies to live in. If the rise in long-term interest rates persists, would could see household wealth settling at around 550 per cent of GDP, a level last seen in 2007. But, if downward pressure on long-term interest rates resumes, this could see wealth settling at around ten-times GDP.

The future path of long-term interest rates matters hugely in the context of intergenerational inequality. Higher rates of return make it significantly easier to save for retirement. Pre-pandemic, a 40-year-old with median earnings needed to save approximately 16 per cent of their gross income (just over £5,000 a year) to reach a retirement target replacement rate of two-thirds of gross earnings. However, with current rates of return, the required contribution rate for the same goal is much lower at 9 per cent (£3,000 per year).

A higher-rates world would also improve housing affordability, helping young, would-be homeowners. Based on current interest rates, the house-price-to-earnings ratio could fall to around 5.6 – the lowest level seen since 2000. But if ultra-low rates return, there would be further upward pressure on house prices, with our modelling suggesting that they could reach 11 times earnings.

Notes
In 2018-20, pension wealth accounted for 43 per cent of total household net wealth, with housing a further 36 per cent. By Q1 2023, we estimate that these shares have changed to 35 per cent and 43 per cent respectively.

abrdn Financial Fairness Trust supports work to tackle financial problems and improve living standards for people on low-to-middle incomes in the UK. It is an independent charitable trust registered in Scotland funding research, policy work and related campaigning activities.

[b]Read the full report HERE
Pdf 63 Pages.