How does quantitative easing affect mortgage and saving rates?

Quantitative easing (QE) was adopted by the US, European and UK central banks as a response to the banking crash in 2009. How can this monetary policy affect mortgage and saving rates?

| 7 min read

Central banks have a big impact on our savings and borrowings. They can lower or raise the key market interest rate that affects borrowing costs and income returns on deposits and bonds. In recent years they cut rates and bought up a large quantity of bonds or government debt in the market, boosting its price and lowering the interest rate you get. Borrowers and savers alike benefitted from these policies, cutting the cost of loans, and boosting the prices of bonds and shares. There were a couple of downsides. People wanting just to keep savings as cash deposits with banks earned less and less interest on their money. More recently inflation has accelerated, which some think is in whole, or part caused by all the extra money the central banks created and the extra borrowing they encouraged. This has forced a change of policy which meant last year many people lost money on holding shares and bonds.

Today some of the central banks are now doing the opposite to quantitative easing. They are raising rates and they are selling the bonds back into the market, cutting bond prices and driving interest rates higher. It is why we need to examine carefully what Central Banks are doing to understand what might happen next to savings and loans.

What is quantitative easing?

First started by the Bank of Japan in March 2001, quantitative easing (QE) was also adopted by the US, European and UK central banks as a response to the banking crash in 2009. It was also widely used on a big scale as an offset to the economic impact of lockdowns to tackle Covid-19 in 2020-22. This is how QE works in practice:

  1. The central bank announces it will buy up large quantities of state debt with a view to raising its price and therefore lowering the interest rate.
  2. As most of these bonds offer a fixed income to the holder, the central bank can lower the interest rate by increasing the price of the bonds, so your fixed income payment is a lower percentage of the cost of the bond.
  3. The central bank creates the money in an account to buy the bonds, calling the created money central bank reserves. The money sent to the sellers of the bonds is usually first deposited in bank accounts, which the commercial banks often then deposit back with the Central Bank before they can find ways of increasing their loans or buying other assets.
  4. If all the money is retained as cash or spent on replacement existing investments the inflation created will be in financial assets which are deliberately bid up in the process. If more of the money is used to lend on or spend then there should be some upturn in activity and there could be a wider inflation if too much money is released.

What is quantitative tightening?

Quantitative tightening (QT) is the reverse process to QE. When central banks want to slow an economy and get inflation down, they sell bonds back to the market, removing cash from bank customers and their banks. This lowers the price of the bonds and drives up interest rates, deterring more borrowing. People and institutions which buy the bonds cannot spend that money on something else.

Are central banks practising QE or QT?

  • The Federal Reserve in the US had a very large QE programme which ended last year. It is now selling bonds back to the market, and has driven interest rates up from very low levels in an effort to rein in the economy and bring inflation back down. The official rate is now 4.25-4.5%, up from 0.25% and the rate of interest for the US government to borrow for ten years is 3.5%, up from 0.6%. As a result housing transactions and mortgage take up have fallen a lot and more general signs of the economy slowing are appearing. Inflation has peaked.
  • The European Central Bank continued with a large quantitative easing programme for longer. It is still reinvesting money from bonds that fall due for repayment. It will start modest reductions from March. Its official rate is now 2.5%. Faced with a high inflation rate the ECB is also constrained by the wish to avoid undue stress in bond markets in some of the more heavily indebted countries so it has been less aggressive in reining in quantitative easing.
  • The Bank of England ended its quantitative easing programmes last year and is now selling bonds back to the market. It raised rates to 3.5%.
  • The Bank of Japan has been fighting price falls, low inflation and slow growth ever since the share, property and banking crash at the end of the 1980s in Japan. Successive programmes of quantitative easing have allowed the Japanese government to borrow huge sums of money at zero interest in efforts to stimulate the economy more. Inflation has stayed low despite all the money created as an ageing population has not gone out and borrowed and spent to excess. The Bank of Japan has recently reaffirmed its intention to buy as many bonds as it takes to keep the ten-year rate of interest at zero . Although inflation has now hit 4%, twice the target, the Bank thinks it will fall away again later this year.
  • The Peoples Bank of China kept interest rates higher throughout the Covid-19 crisis, with them currently at 3.65%. The Bank did not undertake any QE programmes of state bond buying, though it has offered liquidity to the banking system from time to time when things were tight. Inflation has stayed around 2%.

What does QE & QT mean for savers, investors, and borrowers?

Either side of the Atlantic markets are adjusting to life with higher interest rates and less central bank money around to sustain bond prices. Much of the fall took place last year, so bonds are offering better income levels at the new lower prices. Many shares were also dragged down. The big bull market up to the end 2021 had been partly fuelled by investors taking money from their sales of bonds to the central banks and reinvesting it in shares. Investors are watching carefully to see how much higher interest rates are going to go, which will have a substantial impact on how long and deep the downturn becomes.

If the central banks overdo the rate hikes and the bond selling, too few can afford to borrow and there is too little money around for extra spending, so there is less economic activity. Current thinking in markets is the main central banks will not overdo the interest rate rises, and maybe we have now seen the bulk of them. If so, the investment outlook starts to improve. Were the central banks to become too wedded to more rate rises and more bond selling we will be in for a deeper and longer downturn.

Nothing on this website should be construed as personal advice based on your circumstances. No news or research item is a personal recommendation to deal.

How does quantitative easing affect mortgage and saving rates?

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