Metrics Monthly Q2 | 21

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Is increased inflation on the way?

David Wylie considers how a return of high inflation and increased interest rates could impact the lending sector

When you add to this mix the fact that pent-up consumer demand is going to be released over the coming months following its suppression by the pan- demic, you could be forgiven for think- ing that we are in-line for a steep rise in the next published Retail Price Index. There are many who expect prices to rise faster and further than the Bank of England’s prediction of broadly 2% this year and the same in 2022. I am with those economists who see it being more like at least 4% by the second half of next year. If inflation does rise steeply at the end of this year and into next, how is it going to play out in our own sector? As night follows day, if prices do rise by more than 3%, interest rates and the cost of borrowing are likely to rise as the BOE tries to restrict price growth. The only likely alternative will be a tighter fiscal picture as the government increases taxes (to pay for the events of the pandemic) and reigns in spend- ing. Such actions would also dampen demand.

This will mark a major turning point for the industry. For the past 20-or-so years, borrow- ers have largely come to expect low and falling mortgage and loan interest costs. Overnight, they may have to get used to the opposite. As the cost of borrowing rises across all types of applicant, lenders will be looking to recalibrate their exposure and scale back lending at the margins of their client distribution. This may lead to ‘pulling up the ladder’ on riskier lending, such as to the self-employed. This is going to mean a re-adjustment for all and, for some, this may be painful. Spending decisions might have to be postponed, given that relatively inex- pensive finance will be suddenly more expensive. Loan applications that were expected to sail through on affordability will be turned down, and agreed advanc- es on mortgages may come up short as LTV requirements change. The scale of the difficulties these changes may cause is, of course, going to be proportionate to the actual level of inflation that the economy experienc - es and the real interest rates that then apply.

All of this is exactly what happened during every previous inflationary period, so no big surprises; history does in fact repeat itself. Thankfully, however, for the first time there will be a big difference this time round. We now have vastly improved technology at our disposal in this sector to help cushion adjustment to a new reality. The ‘Big Data Revolution’ that we have all been living through means lenders can take a granular view of their activity, where every individual applicant has an individual decision, tailored to their spe- cific circumstances. This allows for a far more intelligent calibration of risk by lenders, enabling them to tune-in more accurately to their customers and there- fore their profit-and-loss, so that they can maximise prudent lending and min- imise missed payments and bad loans. The quiet back-office revolution that has been taking place under the radar since the previous inflationary burst should give us all grounds to be con- fident that we can weather the storm, should it come. Gen Zs and Millennials can rest assured, most of the industry is now in a much better position to ride the storm than last time.

The days when high inflation rates loomed large on the horizon are long gone. To ‘Gen Zs’ or Millennials it has really never been a concern. Since around 1993 it has ticked along at around the 2%-or-under mark. Its impact on the real value of salaries and savings: minimal. 2011 was the last time price rises surprised anyone, when they briefly nudged over the 4% mark (4.46%). Prior to that, you have to go all the way back to 1992 to get the previous high-water mark (4.23%), after which prices drifted steadily southwards. For those of you with memories that pre-date 1992, I imagine, like me, you will have always felt inflation was there in the background, biding its time, waiting for the next opportune moment to strike. You can scarcely blame us. I can

remember inflation of 7.5% in 1991 under John Major’s Conservative Gov- ernment and can recall being told as a child about the 24% (yes, you read it right - 24%) under Labour and James Callaghan in 1975. During those years, and the years in between, high inflation wasn’t unusual, and with it came higher interest rates. During the Major years, interest rates topped 15%. The consequence was misery for many of those with mortgag- es and a drastic pinch on disposable incomes. I’m sure I was not the only one to have wondered when that container ship got stuck in the Suez Canal at the end of March whether inflation was about due for another run. Was the supply bottle- neck that it caused going to compound the damage to an already fragile trading environment and mark the turning point?

Looking at the data, I think a lot of drivers are indeed in place for a resur- gence. We may well come to look back on 2021 as the beginning of a new infla - tionary period. "We may well come to look back on 2021 as the beginning of a new infla - tionary period." On the supply side, commodity prices are briskly picking up. The World Bank commodity index bottomed out in 2020 at 91.7 in quarter two, but in the first quarter of 2021 it hit 139.9. Drilling down further: oil prices are up a third compared to last year (but still low his- torically); house prices, boosted by the Stamp Duty holiday, show no signs of cooling; car prices are up, as are home energy costs and food prices.

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