Inflation could be a useful political tool

19 July 2010

Our parents’ generation paid off their mortgage debt in part due to bouts of inflation.

In the past decade a low inflation environment has meant consumers have had to embrace the idea that they must pay back every penny they have borrowed. But this may be about to change.

The UK’s deficit may be tackled primarily with housekeeping measures such as higher taxes and spending cuts. But like our parents’ generation, a period of higher inflation could be just the thing for politicians if they believe that controlling the deficit is not possible with conventional tools.

What could this mean for borrowers? We should not assume that inflation this time round would be like that seen in the 1970s - for example, we are not seeing incomes grow - but some effects may seem rather familiar.

Rising variable rates would boost demand for remortgaging, while paying off the mortgage would become less attractive as inflation effectively erodes borrowers’ debts.

Throw in rising house prices and diminishing LTVs and the market could change quickly. Of course, this does not mean lenders will respond as they did in the past, and that’s another challenge.

For a full recovery in confidence the government must work out how it can galvanise income growth, but the political priority is the deficit.

While inflation won’t please everyone the government needs every tool at its disposal as well as the skill and nerve to use them effectively. Inflation might prove to be a helpful one.

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