ALEX BRUMMER: As interest rates climb and the air comes out of the debt bubble, there will be victims on our doorsteps
- Increase in global rates changes environment for highly-indebted companies
- Low interest response to financial crisis and Covid has left a toxic debt legacy
- IMF reported that 2020 saw largest one-year debt surge since Second World War
The main merit of this week’s rise in the bank rate is its shock value. In much the same way as the North Shropshire by-election is a huge wake-up call for Downing Street about the need for a more disciplined and ethical politics, the interest rate rise – from a lowly 0.1 per cent to 0.25 per cent – sends a powerful message to global finance.
The Bank of England may have become a leader rather than a follower in plotting a path to normalisation of borrowing costs, but eventually other central banks will take similar steps.
Technically banks normally welcome a rise in official interest rates. Near-zero rates do nothing for banking incomes, so even a small notch upwards on the dial offers a chance to improve interest rate margins by widening the gap between rewards for savers and the charge to borrowers. It also makes all of those tens of billions of pounds sitting in customer current accounts doing nothing much more valuable.
Heavy load: Every small move upwards in global interest rates changes the environment
But for those investment and commercial lenders, which are big players in the debt markets, it poses a new problem.
Every small move upwards in global interest rates changes the environment for highly-indebted companies and, for that matter, countries.
A court judgment in Canada this week put the spotlight back on Cineworld, the acquisitive UK-based movie-house operator which has used a debt model to expand. The springboard and tax advantages that debt provides in times of low and stable interest rates can be a source of great riches.
But a strong and rising cash flow is needed to service that borrowing. An accidental setback can put that in jeopardy.
The low interest response to the financial crisis and Covid-19 has left in its wake a toxic debt legacy.
The International Monetary Fund reported this week that 2020, the peak year of the pandemic, saw the largest one-year debt surge since the Second World War, with the total rising to $226trillion.
The IMF’s monitor shows a 28 per cent jump in global debt to 256 per cent of world output. Borrowing by governments accounted for more than half. Sovereign governments don’t generally go bust. When Greece came close to collapse, in the eurozone crisis of 2011, a safety net was put in place.
Of more concern to business, banks and, ultimately, private investors and consumers is the Everest of private sector debt which stands at 178 per cent of world GDP.
Glimpses of the fissures have been seen in recent months. The Evergrande and wider real estate implosion in China provides insight as to what can happen when borrowing can no longer be serviced, even in a country where it is assumed that a centralised government is assumed to stand behind commercial entities. There is no guarantee that it will step in.
Much of the rise in private sector debt in the pandemic reflected the willingness of businesses such as aerospace to take on more debt for survival.
The airlines were able to do so with the help of government guarantees and schemes such as the UK’s wide range of Covid lending plans. Rising interest rates and the impact of Omicron are a new threat to such companies. A pertinent worry for UK plc is the impact on those firms which took the private equity shilling in the pandemic.
In the case of fast-burn deals such as the Advent purchase and dismantling of Cobham, debt rapidly has been paid down.
Of greater anxiety will be the tightening of debt markets for deals pending, and under government scrutiny, such as Meggitt and Ultra Electronics, along with those already done, including Morrisons and Asda.
It may already be too late to protect Morrisons and Asda from harms. Both of the supermarket groups have been piled high with debt and bonds and the new owners have already encountered problems in putting some of the borrowing on a long-term sustainable basis.
The consequence is that the pressure will grow for cost cutting and asset disposals to improve cash flows and make the debt more affordable. At Morrisons, one fears that plans to invest in the business so it can compete better in the forecourt-convenience space will be sacrificed along with vital assets, such as its freehold properties and farm-to-store food production strategy.
As interest rates climb and the air comes out of the debt bubble, there will be victims on our doorsteps.