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Inflation, Mortgages and the Insurance Market

In almost all areas of the world central banks have pumped billions of dollars into the economy. The vast fall in credit market liquidity and the resulting economic downturn forced central banks to abandon monetary policy techniques that appeared to work so well over the previous ten years. In desperation central banks resorted to the age old trick of printing money, the impact of which has been twofold.

Firstly, an increased level of cash in the economy has helped to ease credit market tension and promote economic recovery. Secondly, simple monetary economics tells us that there will be a resulting burst of inflation (quantity theory of money). The monetary transmission mechanism would indicate that monetary easing (printing money or lowering interest rates) will have an impact on economic growth in the first place (typically after 12 months) and inflation secondly (18 months).

I think it is fair to say that a stabilisation in the economy has been witnessed in the last 6 months, with growth rates teetering on the border of positive. What we are now starting to witness is the secondary impact, rising inflation. In the UK, inflation is recording record monthly growth under the CPI measure and the highest rises since the 1970’s under the RPI measure. The question is whether these rises are to continue? Given the amount of cash central banks have pumped into the economy it is difficult to see otherwise.

If inflation continues to rise it is difficult to see what central banks will do, risk further recession by increasing interest rates or accept the consequences of sky high inflation? In either case, rising interest rates or rising inflation are likely to force mortgage lenders to increase the interest rates they charge on their loans. Even if central banks keep official rates fixed for some time, high rates of inflation may force lenders to raise rates in order for them to make a real return on their investments (i.e. to avoid negative real interest rates).

For new home buyers it would probably be advisable to take out a fixed rate loan. For existing mortgage holders times might be difficult in an era where loan repayments are likely to rise and wage freezes are prominent (especially as inflation would lower real wages and reduce disposable income). If central banks decide to raise interest rates to tackle inflation there are likely to be negative economic consequences which will probably result in further redundancies.

The insurance market cannot cover individuals who fail to make their payments due to rising monthly repayments but it can cover those individuals who are forced into unemployment. In these uncertain times has become extremely popular and, given the unclear future, a very sensible form of financial protection.

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Monday, May 17th, 2010 Insurance News