Rising interest rates have caused household wealth across Britain to fall by £2.1 trillion over the past year, but there are winners – concentrated among younger generations – as well as losers if higher rates are sustained, according to major new analysis by the Resolution Foundation and abrdn Financial Fairness Trust.
The report notes that Britain has experienced an unprecedented wealth boom in recent decades, with total household wealth rising from around 300 per cent of national income in the 1980s, to 840 per cent – or £17.5 trillion – by 2021.
However, the Bank of England’s rapid rate-rising cycle since late 2021 has caused mortgage rates to rise, house prices to fall and, critically, the price of government and corporate bonds to plummet.
Falling bond prices have reduced the measured value of pension assets (largely in DB schemes, or already in payment), normally the biggest single source of household wealth in Britain. The Foundation’s estimates suggest total household wealth has fallen to 650 per cent of national income in early 2023 – a cash fall of £2.1 trillion over the past year and the biggest fall as a share of GDP since World War II.
If higher rates remain (markets currently expect Bank of England policy rates to still be at 5.5 per cent in mid-2025), it could drive further falls in wealth to around 550 per cent of GDP. This would end the 40-year wealth boom that has been a key driver of intergenerational inequality – with surging house prices and pension values largely benefiting older generations at the expense of young people, many of whom have been locked out of home ownership altogether.
The Foundation’s analysis shows that persistently higher interest rates would have two key long-term effects – lowering house prices and making it easier to achieve a decent standard of living in retirement by raising rates of return on pension savings.
Higher interest rates could reduce the house-price-to-earnings ratio from its 2022 peak of 8.9 to 5.6, a level not seen since the turn of the century. Were this adjustment to happen over five years, it would mean house price falls of around 25 per cent in cash terms.
Although rising rates are causing a crunch for mortgagors – the 1.7 million households re-mortgaging next year are set to see their annual repayments rise by over £3,000 on average – falling house prices will benefit prospective house-buyers.
First, it will reduce the deposit barrier for first-time buyers. Back in the mid-1990s, it would have taken a typical young, first-time buyer couple around eight years to save for a ten per cent deposit on an average first-time home. This figure has risen to 14 years today, but could fall back to around ten years in this lower-wealth scenario.
Second, while rising rates add to the cost of repaying mortgages, this would be more than offset by the lower mortgage principal needed to purchase the house, thus reducing the overall lifetime cost of property ownership for new buyers.
On pensions, the Foundation notes that in the pre-pandemic world, a typical worker would need to save around £5,000 a year to achieve an income in retirement worth two-thirds of their income prior to retiring. Under today’s higher interest rates, the same worker would need to save around £3,000 to achieve that same standard of living in retirement – making it easier for younger cohorts to save sufficiently to enjoy decent living standards in old age.
The authors caution that millions of people are still under-saving for their retirement, and that minimum contribution rates into pension schemes will still need to rise, but by far less than in a low-interest-rate world.
Of course, the current rate-rising cycle could be a blip in an ongoing long-term trend towards lower interest rates. In such a scenario, wealth would continue rising – reaching ten times national income in the longer term and reinforce, rather than reverse, some of the generational strains Britain has seen build up over recent decades.
Ian Mulheirn, Research Associate at the Resolution Foundation, said “Over the past four decades wealth has soared across Britain, even when wages and incomes have stagnated. But rapid interest-rate rises have ended this boom and brought about the biggest fall in wealth since the war, of £2.1 trillion.”
“Those with significant mortgages will be hit by these major changes. But there are winners too from a shift to a world of higher rates and lower wealth. Higher returns will make it far easier for younger people to save for a pension that delivers a decent standard of living in retirement, while lower house prices will make it easier for younger generations to get on the property ladder and others looking to trade up.”
“The future path of interest rates is very uncertain. The current surge could be a blip, or herald a new era for the UK. Either way, policy makers should focus more on whether and how to insulate households from wild swings in their fortunes from these forces well beyond their control.”
Mubin Haq, CEO of abrdn Financial Fairness Trust, said “The short-term pain of higher interest rates for mortgage holders could also mean a longer-term gain for young people hoping to buy their own homes and saving for their pensions. Both become more affordable and allow for a fairer sharing of wealth. In these turbulent times, when assets have tended to held by older generations, we may see rising interest rates reversing the growth in wealth gaps Britain has seen over recent decades.”