Inflation for beginners.

"Tell ya what mate, that inflation fings gone nuts innit" said a good friend of mine in the pub this week, whilst we commented on the lack of gas in our Fosters. "Yep, double the government target now. One sure way to control that is by increasing the base rate. Pretty sure we'll see the base rate go up now my fine friend" i replied. "Tottenham looked good though didn't they..." i continued.

Ben paused. Took a sip of his gasless Fosters and came back at me. "Why's that then mate?!" He said. "Well, we had so many players out, but still graced the pitch with a style and grace that no one thought we could have done" i said. "Nawwwwww you doughnut" said Ben in a high squeal. "Why will an increase in the base rate control inflation?"

It was then that it dawned on me. I often write about how increasing the base rate will control inflation. I often tweet about how the rate of inflation is a key factor in The Bank of England's decisions on the base rate. But i never explain why. So, for the sake of Ben and many others that often hear these comments but never understand them, i am going to break it down a little bit for you.

Ben, this one is for you buddy.

The government set a target for what they feel inflation should be. This target is set at 2%. So what does 2% inflation mean? Well, in Ben's terms it means that pint of Fosters he is drinking for example would cost 2% more this January than it did last January. However inflation was announced at 4% for January. This is double the 2% target. So, Ben's Fosters in Jan 2010 would have cost him £2.80p. January 2011, it would have cost £2.91. And there we have it. Inflation, described with the use of a pint of Fosters, in very very simple terms. Its double what it should be, everything is too expensive, the government need to sort it.

So how does increasing the base rate do this? I hear you cry. Well lets go back to Ben. Look at him, standing there at the bar at 4.13pm on a Thursday (lets ignore the fact i am standing beside him please). The reason Ben is standing there is because i sorted him out with a nice lifetime tracker deal a few years back with Woolwich at...drum roll please...0.17% above base for the life of the loan. So while base rate has spent near on 2 years on 0.5% Ben has been paying 0.67% interest on his interest only mortgage! That is why he can afford to drink all afternoon, why he can afford the £170 jeans he wears, the flash watch and the BMW M3 Convertible he drives way too fast.

HOWEVER! If the base rate were to increase, what happens? Ben's mortgage gets more expensive, the finance on the car gets more expensive. Ben's disposable income goes down. The luxury items have to get sacrificed to compensate for the increase in the payments. Demand for items drop, demands for services lower (he stops dry-cleaning his Y-Fronts), shops can't sell, prices comes down...inflation CONTROLLED!

That is a very very basic understanding of how increasing the base rate can help reduce inflation. Think of it in the bigger picture however. With the base rate at 0.50% there is no encouragement to save. Stick that in the bank and your returns will be pitiful. So, no one is saving. They are spending while the cost of borrowing is so cheap. Companies will buy equipment, because they can afford to. People will spend more on luxuries, because they can afford to. They will spend more on services and no one will save. What people should be doing is clearing their debt, but that is another diary entry. The Bank of England Base rate does not just effect mortgages. It effects savers, pensioners, it effects business, services, retailers, it actually effects everyone in a lot more ways than people realise.

So Benny boy, inflation is here, its out of control, but like your drinking, it can be controlled by an increase in the base rate. So be warned...rates will soon be a rising but with your 0.17% over base...you'll be alright! No need to jump ship yet. You don't know how lucky you are my friend.

And so endith our basic economics class. I trust you enjoyed it.

Ben, mines a Becks Vier please mate, this Fosters is too flat. Oh, you've forgotten your wallet?! Why i oughta....

The Secret Diary of Mortgage Broker aged 13 and 2/12ths.

The role of a mortgage broker has certainly changed over the years. It has to be said that in recent times I have felt a little bit like a firefighter, stuck in a towering inferno with nothing but a water pistol to extinguish the flames (by the way that is not me stage right but i was told visuals help a blog!) Or a little bit like a captain of a ship, pulling into the dock to pick up the awaiting 500 passengers...in a 2 man dingy. The comparables could go on, but lets surmise by saying I don't quite feel I have had the ammunition lately to go in to battle (oops, there is another one!)

However, I can see some light at the end of the tunnel. Activity has increased, the phone is ringing again, and as I write this blog, the "pings" of incoming emails are constant and this time it is not purely The Telegraph updating me on my Fantasy Football Team (which isn't doing too badly might I add!)

So, the last few days have been pretty manic. Why? Because the lenders anticipate a rate rise. It is the only real way of tackling a runaway train like inflation at the moment. In light of this, swap rates have increased which means the cost of borrowing to lenders has increased. This is then passed on to us the consumer, and the fixed rates we see are getting more expensive. Last week we saw lender by lender, pulling their fixed rates from the market, and replacing them with fixed rates at a higher margin. In some instances, lenders have even withdrawn rates and not replaced them. Skipton for one are so busy at the moment they are not launching new products until next week to catch up with their levels of service.

I have many clients, as do many of us brokers, enjoying the good times on variable rates with the likes of Nationwide and Cheltenham & Gloucester of 2.5%. No ties, no fees, why on Earth should they change?! If I could offer clients a deal of 2.5% with no fee and no redemption penalties they would be biting my arm off! This takes me back to my first paragraph...I just don't have the ammunition right now. But with today's announcement of inflation being 4%, I can divulge in my secret diary that to me, this is a blessing in disguise as this will bring with it an inevitable increase in the base rate and it will result in all of these clients seeing rates going up. That is the time they call their broker and start to address what to do.

So, in my first post of my Secret Diary I can tell you that Inflation at 4% means the Base Rate will surely rise in the next 3 - 6 months if it stays around this level, and that I...will be a very happy mortgage broker.

But hey, don't tell anyone. Its our little secret!