Hamish McRae: Beware the real effects of low interest rates

The Federal Reserve and the Bank of England have become like Mr Micawber in reverse.

You may recall that Charles Dickens’ rather loveable character in David Copperfield, based apparently on his own father, was always relentlessly optimistic.

Whenever things looked really bad, he proclaimed his faith that “something would turn up”.

It never did. As far as the Fed and the Bank are concerned, whenever they consider that things look good enough for it to be safe to increase interest rates, something does turns up. But it is disagreeable, and is deemed to stop them.

These have included the second eurozone recession, the various legs of the Greek crisis, poor data on the UK economy, the collapse of the oil price, and most recently the slowdown in China.

These have mostly proved less serious than they first seemed. Europe’s problems have had regional rather than global consequences. Greece is a sideshow, albeit a deeply troubling one.

The UK economy has grown reasonably steadily every year since the crisis and, as the latest figures confirm, the alarmist data of three years ago was plain wrong.

The oil price did push headline inflation into negative territory in most developed countries but it has given a net boost to real consumption pretty much worldwide.

As for China, some slowing of its helter-skelter growth was essential and may also be a net positive to growth in the developed world.

At the annual meetings of the International Monetary Fund and World Bank in Lima last week, Bank of England Governor Mark Carney restated his view that UK rates might move up around the end of this year.

Maybe they will but that is not what market rates indicate. Indeed, these suggest the first move may not come until much later in 2016.

Meanwhile, the negative impacts of near-zero interest rates have become more and more apparent. They do not, however, get as much publicity as they deserve, so here is a checklist of six of the most damaging effects.

1. Wealth inequality. There has been great concern about income inequality, which has not risen much and on some counts has fallen, but far too little about wealth inequality, which has shot up and arguably is more pernicious.

It is also harder to offset by taxation. Asset prices have soared as a direct result of quantitative easing — and, of course, the more assets people have, the more they have benefited.

2. Property prices worldwide. Most assets have been boosted but what has happened to residential property has been particularly damaging.

We see it in Britain, especially in London and the South-East, but much the same is occurring in New York, Berlin and Mumbai.

3. Pension poverty. Cheap money has deliberately held down government bond yields, which pension funds are compelled to hold for regulatory purposes.

This has pushed down annuity rates, giving pensioners a double hit.

4. Cheating unsophisticated savers. Cheating is a strong word but the effect of such low rates has been felt hardest by those who have no access to specialist advice on how to get a better return on cash by taking it out of the bank and putting it into a portfolio of financial assets.

5. Encouraging risk-taking. Savers may be taking on ill-understood risk in seeking higher returns.

Borrowers may be overextending themselves by believing the central banks will keep rates low for the foreseeable future — which they may not be able to.

6. Long-term damage to the financial system. It is hard to pin this one down because you cannot see the true damage for many years. But the very low rates are encouraging people to bypass banks, and that is showing through in a number of ways.

The use of cash has risen sharply worldwide, and there are other hard-to-measure effects including peer-to-peer financial transactions.

Not all this is bad, and low returns encourage innovation. But by seeking to reduce risk in one section of finance — banking — the authorities are increasing it in others.

To this half-dozen damaging effects already evident, there is another round the corner: inflation.

The central banks have certainly created asset inflation and some believe this constitutes a price bubble that will have to be pricked.

I am not so worried about that, but what I think may be just round the corner is a burst of current inflation – inflation in goods and services.

The Resolution Foundation today publishes a report showing that UK private-sector wages are rising at the fastest rate for 15 years.

In one sense, that is welcome — about time, you might think, that working people get a better reward after years of wage compression.

But that will feed through into costs in the coming months just as the one-off effect of lower oil prices fades. There are similar latent pressures in the US.