Markets do set rates: A reply to Julien Noizet
Financial analyst and blogger Julien Noizet has replied to my article on mortgage rates on his blog. It is a good piece, worth reading, but I still think I am right. It is perhaps true that Noizet is right too, because my claim was really very modest: in total, mortgage interest rates do not mechanically vary with the Bank of England's base rate; we can show this because the spread between them and the base rate varies extremely widely; and since we have very strong independent reasons to expect that market forces largely drive rate moves, that should be our back-up explanation. The implication of this I was interested in was that this meant a hike in Bank Rate wouldn't necessarily drive effective rates up to a point that would substantially increase the cost of servicing a mortgage and hence compress the demand for (London) housing.
Even if the first graph in Noizet's blog post did appear to support his narrative that effective market rates follow Bank Rate moves, I'm not sure why these disaggregated numbers matter given that the spread between overall effective rates on both new and existing mortgages varied so widely. If it turns out that specific mortgage types varied closely with Bank Rate but the overall picture did not, then markets still control effective rates, they just do it via a changing composition of mortgages, not by changing the rates on particular products. The effect is the same—and it is the effect we see in the Bank's main series for effective rates secured on dwellings. But the graph, to me, looks a lot like mine, despite the effect of new reporting standards: mortgage rates are about a percentage point from the base rate until 2008, then they don't fall nearly as far as the base rate in 2008 and they stay that way until today. If other Bank schemes, like Funding for Lending or quantitative easing were overwhelming the market then we'd expect the spread to be lower than usual, not much higher.
His second big point, that the spread between the Bank Rate and the rates banks charged on markets couldn't narrow any further 2009 onwards perplexes me. On the one hand, it is effectively an illustration of my general principle that markets set rates—rates are being determined by banks' considerations about their bottom line, not Bank Rate moves. On the other hand, it seems internally inconsistent. If banks make money (i.e. the money they need to cover the fixed costs Julien mentions) on the spread between Bank Rate and mortgage rates (i.e. if Bank Rate is important in determining rates, rather than market moves) then the absolute levels of the numbers is irrelevant. It's the spread that counts. But the whole point of my post is demonstrating that the spread changes very widely, and none of Julien's evidence seems to me to contradict that claim. Indeed, Noizet's very very good posts on MMT, which stress how deposit rates are much more important as a funding cost than discount rates for private banks, seem at odds with what he's written in this post. And supporting this story is the fact that the spread between rates on deposits (both time and sight) and mortgages changes much less widely. If we roughly and readily average time and sight on the one side and average existing and new mortgages on the other, the spread goes no higher than 2.3 percentage points and no lower than 1.48.
In general with the post I don't feel I understand the mechanisms Noizet is relying on, perhaps I'm misunderstanding him, but the implications of his claims regularly seem to contradict our basic models of markets. For example, he says that a rate rise would lead banks to try and rebuild their margins and profitability. But I can't see any reason why banks wouldn't always be doing that. The mortgage market is fairly competitive, at least measured by the numbers of packages on offer and the relatively small differences between their prices. I don't think Julien has presented any mechanism to suggest why banks would suddenly want to maximise profit after a rate rise but wouldn't beforehand—or why they'd suddenly be able to ignore their competitors but couldn't beforehand. It's possible there is one, but I can't see that he's explained it. Overall I suspect I've missed something crucial, so I welcome any more comments Julien has on the issue.