The Bank of England has raised its base rate from 0.1% to 0.75% in October 2023, the highest level since 2009, in an attempt to curb inflation and stabilise the economy. However, this has also had a negative impact on the wealth of UK households, which has fallen by £2.2 trillion in the third quarter of 2023, according to a report by the Resolution Foundation.
The main reason for this decline is the drop in house prices and pension pots, which are sensitive to changes in interest rates. Higher interest rates make borrowing more expensive, reducing the demand for mortgages and lowering the value of properties. They also increase the discount rate used to calculate the present value of future pension payments, reducing the size of pension pots.
The Resolution Foundation estimates that the average UK household has lost £34,000 in wealth due to higher interest rates, equivalent to 15% of their total wealth. This is more than the annual income of a typical worker.
Who are the most affected by the wealth loss
The report also reveals that the wealth loss is not evenly distributed across different groups of households. The most affected are those who have high levels of debt, low levels of savings, and large exposure to housing and pension assets.
For instance, younger households, who tend to have more debt and less savings, have seen their wealth fall by 21%, compared to 11% for older households. Similarly, households in London and the South East, where house prices are higher and more volatile, have seen their wealth fall by 19%, compared to 13% for households in the rest of the UK.
Moreover, the wealth loss has widened the gap between rich and poor households. The richest 10% of households have seen their wealth fall by 9%, while the poorest 10% have seen their wealth fall by 33%. This is because poorer households have a higher share of their wealth in housing and pensions, which are more affected by interest rates, while richer households have a higher share of their wealth in financial assets, such as stocks and bonds, which are less affected by interest rates.
What are the implications of the wealth loss
The loss of household wealth has significant implications for the economy and society. The Resolution Foundation warns that it could reduce consumer spending, which accounts for about two-thirds of the UK’s economic activity. Lower spending could lead to lower growth, lower tax revenues, and higher unemployment.
The wealth loss could also affect the well-being and happiness of households. The report cites evidence that shows that changes in wealth have a larger impact on subjective well-being than changes in income. Therefore, losing wealth could lower people’s life satisfaction, mental health, and confidence.
The report urges the government and the Bank of England to take measures to mitigate the negative effects of higher interest rates on household wealth. It suggests that they should provide more support for low-income households, such as increasing benefits and tax credits, and ensure that monetary policy is not tightened too quickly or too much.