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A recent report reveals that the surge in interest rates has led to the largest decline in British households’ aggregate wealth in the postwar era, in terms of its share of national income.
According to estimates by the Resolution Foundation think-tank, British households’ total wealth has dropped by £2.1tn in cash terms. However, the report suggests that tighter monetary policies might have a positive impact on younger individuals.
The report states that UK households’ wealth represented 650 per cent of the national income in early 2023, a significant decline of nearly 200 percentage points compared to early 2021.
Ian Mulheirn, a research associate at the Resolution Foundation, explains that wealth across Britain had been soaring for the past four decades, but rapid interest rate increases have abruptly ended this trend, resulting in the most significant wealth decrease since the war.
This decline is mainly due to a decrease in asset values, including house prices, government bonds, and corporate bonds. Falling bond prices have also reduced the value of pensions, which is typically the most substantial source of household wealth in Britain.
If interest rates continue to remain high, the Resolution Foundation estimates that households’ wealth could fall even further to approximately 550 per cent of gross domestic product.
Financial markets anticipate that Bank of England rates will reach 5.5 per cent by mid-2025.
The report, conducted in collaboration with the abrdn Financial Fairness Trust, a charitable trust, revealed that households’ wealth had soared from about 300 per cent of GDP in the 1980s to 840 per cent (£17.5tn) by 2021.
However, this wealth boom has contributed to intergenerational inequality, as rising house prices and pension values predominantly benefited older individuals at the expense of younger generations, many of whom face challenges in becoming homeowners.
Mubin Haq, the chief executive of the abrdn Financial Fairness Trust, suggests that these turbulent times might reverse the wealth gaps that Britain has experienced in recent decades, particularly as assets are often held by older generations.
Rising interest rates are creating financial difficulties for many families with mortgages. The Resolution Foundation estimates that around 1.7 million households will see their annual payments to lenders increase by over £3,000 on average next year.
However, tighter monetary policies could potentially reduce the house price-to-earnings ratio from its peak of 8.9 in 2022 to 5.6, a level not seen since the millennium.
If this trend continues over the next five years, it could lead to a 25 per cent decrease in house prices in cash terms, which would be advantageous for young people looking to purchase a home.
Higher interest rates would also result in increased returns on pension savings.
At current interest rates, an average worker would need to save approximately £3,000 per year to achieve a retirement income equivalent to two-thirds of their annual earnings, compared to £5,000 before the Covid-19 pandemic, according to the Resolution Foundation.
This would make it easier for young people to save and maintain a decent standard of living in old age.
Mulheirn points out that there are potential winners in a world of higher rates and lower wealth. Higher returns would make it significantly easier for younger individuals to save for a pension that ensures a comfortable retirement, and lower house prices would facilitate homeownership for younger generations and those looking to upgrade their homes.
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