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Interest rates, inflation and recession in the 80s vs now – are there lessons we can learn?

Are there any lessons to be learnt from the financial turbulence of the 1980s? We take a look at the past to try and learn about the future.

Important notes

This article isn’t personal advice. If you’re not sure whether an investment is right for you please seek advice. If you choose to invest the value of your investment will rise and fall, so you could get back less than you put in.

This article is more than 6 months old

It was correct at the time of publishing. Our views and any references to tax, investment and pension rules may have changed since then.

When we think about the 1980s, it can conjure images of shoulder pads, fast cars, and Gordon Gekko from 1987’s ‘Wall Street’. But the 80s was a decade of immense structural change for the global economy and the UK.

The ‘big bang’ financial reforms made London a centre of finance. Inflation and economic growth were volatile, and the government’s exploration of privatisation of several national industries, like railways and mining companies, led to a wave of national strikes.

While the 2020s aren’t an exact copy of the 1980s, there are some similarities. But are there any lessons to be learnt to help navigate the current decade?

This article isn’t personal advice. If you’re not sure whether a course of action is right for you, ask for financial advice. All investments can fall as well as rise in value, so you could get back less than you invest.

Kathleen Brooks is Founder of Minerva Analysis, a market analysis company. Hargreaves Lansdown may not share the views of the author.

Things can only get better

Compared to the 1980s, the UK economy in 2023 looks in better shape. While that time is associated with glitz, glamour and gleaming excess, the reality, at least for the first part of the decade, was grim. Inflation in the UK peaked at 18% in 1980, unemployment was above 11% in 1984 and stayed above 6% for the entire decade. The UK economy was in recession throughout 1980 and into Spring 1981.

In contrast, inflation so far only reached as high as 11.1% last October and currently sits at 8.7%. The number of employed people in the UK has now recovered after the pandemic and unemployment is close to a historically low 4%. So, the number of people in the labour force is growing, in contrast to the early 80s.

Another key difference is the growth rate. The UK economy has, so far, avoided a recession. Quarterly gross domestic product (GDP) grew by 0.1% in the first quarter of 2023, and growth managed to bounce back in April, rising by 0.2% in the month, after a fall of 0.3% in March. While figures for May show a 0.1% contraction, the UK’s economic resilience so far has been in sharp contrast to the economic contraction of the early 1980s.

Double figure interest rates – a key feature of the 1980s

Another sharp difference between now and then is interest rates. While UK and US interest rates have risen at their fastest pace since the 1980s, interest rates are still much lower.

In the UK, interest rates are currently at 5%, and the market expects them to peak just under 6.5% by May 2024. In 1980, UK interest rates were 14% by year end, this dropped to 10% by 1982. The lowest rate of interest over the entire decade was 7.38% in 1988.

So, interest rates were far higher 40 years ago, and not even the most extreme forecasts are expecting UK interest rates to reach even the lowest level of bank rate in the 1980s.

Housing market resilience

There’s been a lot of discussion this year about how rising interest rates and the surge in mortgage rates will affect households and the economy. Analysts calculate that rising interest rates will impact an additional 0.2% of mortgage holders each month. That’s because, more than half of all mortgage holders in the UK in 2023 have a fixed-term five-year mortgage.

This means that households who have re-mortgaged recently and are re-mortgaging in the coming months will bear the greatest burden of the interest rate hikes from the Bank of England (BoE). Back in the 1980s, the mortgage market was weaker than it is today.

Analysis from the BoE published in 1990, ‘The development of Building Societies in the 1980s’, says “innovations in the range of mortgage products offered” were limited in the 1980s. However, one of the few innovations during that time was the “fixed rate loan, whereby the mortgage is fixed for a number of years (usually two or three).”

Fixed rate loans are now the norm, but they weren’t back then, when many more mortgage holders had variable rates of interest. This caused a surge in house repossessions, which is something that has so far been avoided in the current cycle of monetary policy tightening.

Northern Ireland vs London, how the UK housing market has changed

One indication of the excess of the 1980s was the sharp growth in house price inflation.

Sharply dropping in 1981, house price inflation then surged in the UK between 1982 and 1989, peaking at more than 30% year on year, before dropping again in 1990. At no point during the 80s did house price inflation turn negative.

This contrasts with the latest Nationwide house price figures where despite growth between 2020 to 2022, there was an annual decline of 3.5% in June this year. One explanation for the difference is the housing price affordability ratio, which was much lower in the 1980s.

In 1986, the house price to earnings ratio for first time buyers was three, at the start of 2022, this had doubled to six. Historical shifts in the housing market can also be seen in the regional differences between house price growth.

While the capital city was the shining star of the housing market in the mid-80s, so far in 2023, it’s Northern Ireland. It’s the only region in the UK to experience positive house price growth in both the first and second quarter of 2023. Back in the 80s, house prices in Northern Ireland grew at the slowest pace in the UK.

It’s worth remembering that the 80s was a decade of two halves. After the high unemployment and deep recession of the early 80s, the economy went on to enjoy the boom times that we often associate with the 80s.

So, are the 2020s the reverse of the 80s? Did we have our post-pandemic boom times and are we now staring into an abyss of high inflation and rising interest rates?

To answer this, we may have to look across the pond to the US where target inflation matches our own at 2%. The Federal Reserve Bank of Kansas City’s latest research found that to reach the Federal Reserve’s inflation target, interest rates might have to stay restrictive for some time. Before the first quarter of 2023, the Federal Reserve’s monetary policy stance wasn’t restrictive. In fact, interest rates have only become restrictive in the last seven months.

In the 1981 and 1988 monetary tightening cycles, it took 12 quarters for inflation to fall. So, anyone looking for the Fed to pivot anytime soon, might want to read about monetary policy and inflation trends in the 80s. Historically, inflation tended to be sticky and interest rates stayed higher for a sustained period to bring price growth down.

1980s – a debt-free utopia?

A feature of the 2020s appears to be high levels of government debt. Earlier in 2023, the UK’s debt-to-GDP ratio rose to over 100% of GDP. Added to this, the UK’s current account deficit was 2.6% of GDP in quarter one of 2023.

In fact, since the 80s, the UK’s current account deficit has been on a downward trajectory.

So what happened in the 80s to trigger the deterioration in the UK’s finances?

The simple answer is output of North Sea oil declined sharply. The loss of this rich income stream caused a structural shift in the UK’s balance of payments.

Oil and gas tax receipts as a percentage of GDP had peaked in the mid-80s at more than 30%. However, in the last 40 years it’s mostly hovered at less than 1%. If the government had the same current account position now as in the mid-80s, the problems might be very different.

However, a current account surplus doesn’t mean that the 80s was a debt-free utopia. In a bid to stamp out inflation, the UK government also tightened fiscal policy and government spending fell sharply. So far, the current government hasn’t utilised fiscal tightening as a tool to fight inflation. But, if the 80s are anything to go by, it could be used in the future.

UK Current account as % of GDP

Source: Bloomberg, 31/03/2023.

What does all this mean?

The 80s were an important decade that heralded social and economic change. However, beneath the flashy image of the 80s lies a much more interesting reality. History might not repeat itself, but it can rhyme, so the rest of the 2020s could be a wild ride.

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    Important notes

    This article isn’t personal advice. If you’re not sure whether an investment is right for you please seek advice. If you choose to invest the value of your investment will rise and fall, so you could get back less than you put in.

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