Ex-Bank governor: ‘Fool’s paradise’ is over – now we must let rates rise

Households are living in a ‘fool’s paradise’ because they have mistakenly assumed that low interest rates will last forever, former Bank of England head Mervyn King said this weekend.

Lord King warned that rates will return to ‘normal levels’.

But he stressed that the economy will benefit from the change and that central banks “shouldn’t try to get in the way.”

The veteran of the financial crisis was governor of the Bank of England for ten years until 2013. His opinions are still highly regarded and often form the public debate.

The benchmark rate, set by the Bank and starting the year at 0.25 percent, rose 0.5 percentage point to 2.25 percent last month as inflation spiked sharply.

There are two more tariff decisions before Christmas and markets have already forecast an increase to as much as 6 percent next year.

That has skyrocketed mortgage payments. The average two-year firm deal reached 6.47 percent on Friday — the highest since the 2008 financial crisis — while the average five-year deal was 6.29 percent.

Lord King said: ‘We have been in a fool’s paradise where people seem to believe that we can have very low interest rates indefinitely.’

“The adjustment has to happen somehow and central banks can’t afford to back off arguing, ‘Gosh, assets are falling, this is a terrible surprise.’

Speaking to the Australian Weekend newspaper, he said the recent volatility that has rocked pension funds “was an inevitable consequence of a return to more normal interest rates, which should be very welcome.” Central banks should not try to get in the way.

“The price review will have a significant impact on the portfolios of many investors, including the pension funds that we have seen struggle in London. Those pension funds are now being caught.’

The Bank of England launched an emergency £65bn bond-buyer program to rescue funds that relied too heavily on complex financial products – liability-driven investments or LDIs.

“There will be quite a bit of discussion as to why the pension funds were allowed to borrow a lot through leverage embedded in derivatives transactions,” he said.

Households are facing a cost of living crisis and energy and food bills are rising.

According to a report last week, more than five million families could see annual mortgage payments rise by £5,100 by the end of 2024.

Former Chancellor Kwasi Kwarteng’s failed mini-budget, which prompted action from the Bank of England, sparked market volatility that pushed up government borrowing costs and raised mortgage rates.