Is George too scared to raise rates?

BRITAIN'S £460bn mountain of mortgage and consumer debt could frighten the Bank of England out of raising interest rates, economists warn.

With figures this week set to show no end to the country's borrowing and spending spree, there are fears that any increase in the cost of credit could be disastrous for millions of families.

That in turn could make the nine members of the Bank's Monetary Policy Committee, headed by Sir Eddie George, extremely reluctant to increase rates to choke off inflation. 'They are inhibited already,' said Peter Spencer, professor at London's Birkbeck College and adviser to the influential Item forecasting group. 'They are particularly concerned about this. People talk about banks being 'too big to fail' that have had to be bailed out by governments.

'What we have now is a population so heavily in debt that it, too, cannot be allowed to go down.'

Gary Styles, economist at the Halifax, added: 'This is a very difficult area. The models that people have been using to work out what effect borrowing costs have on the economy would be tested were rates to go up significantly. The effect could be quite a bit sharper than people think.'

At 4%, the Bank's base rate is at its lowest since 1964. While cheap credit has helped keep the economy on track, despite the worldwide slowdown and the after-effects of the 11 September 11 terrorist attacks, it has also allowed millions of people to amass record personal and mortgage debts.

On Wednesday, figures from the British Bankers' Association are expected to show more heavy borrowing last month. In December, the net amount outstanding on mortgages rose by £2.6bn to reach £381bn. On credit cards, the net amount outstanding rose £876m during December to hit £24bn.

More evidence of the roaring consumer boom is expected in the December trade figures, due on Wednesday. They are likely to confirm a record deficit approaching £20bn in trade with the rest of the world last year.

Figures for January retail sales, also out this week, are likely 'to show no sign that consumers are reining in their spending', according to Ross Walker, economist at Royal Bank of Scotland.

Last week, the Bank's quarterly inflation report warned: 'High and rising levels of household debt are a source of vulnerability in the event of a shock to income or a substantial change in interest rate expectations'.

The worry is that the MPC, keenly aware of how exposed many people are to any rise in borrowing costs, may hold off on interest-rate rises for fear of the damage this would cause Middle Britain's balance sheet.

In an added twist, consumers will feel additional pain from any rise because not only do higher rates become more painful the more a person has borrowed, but also any rise starting from a lower interest rate is more significant as a proportion of that rate (see below).

Spencer said: 'For the MPC, the interest rate is a very big lever. Unfortunately, people now owe so much that it may have become a lever too powerful to use.'

High percentage of pain
Low interest rates have not only encouraged consumers to amass an enormous pile of debt, they also make any increase much more painful to those consumers than would have been the case had rates been higher to start with.

How? A one percentage point increase in the mortgage rate would lift the repayments on a £60,000 interest-only mortgage by 20% - meaning householders would have to find £300 a month instead of £250.

But back in 1990, when the mortgage rate was 15%, a rise of one percentage point would have been much less significant. The monthly payment on a £60,000 mortgage would have risen from £750 a month to £800 a month - an increase of less than 7%.

Of course, the absolute sums of money involved in the increased monthly payments are still much smaller with a one percentage point increase in rates today than they would have been in 1990 - by £500 in the case of a £60,000 mortgage.