Mild panic in the City as rate rise nears

'As a life-long Londoner I have never ever seen anything like the current frenzy,' says Albert Edwards of Société Générale. Photograph: Alamy

There is a sense of mild panic in the City as the end of cheap money appears on the horizon. An interest rate rise is nearing.

Maybe not tomorrow, when GDP for the third quarter is expected to be strong, or even next year, but most likely before the Bank of England's target date of late 2016.

Minutes of the last monetary policy committee meeting, published on Wednesday, have added to a sense of unease among those investors who rely on base rates at 0.5% to give them an easy profit. Banks, in particular, have recovered on the back of cheap funds, much of which they have retained to rebuild their balance sheets rather than pass on to customers.

Higher interest rates cannot come too soon for the band of analysts who view the current situation with alarm.

Albert Edwards, Société Générale's global strategist, argues in a note for clients that four years of low rates have encouraged a return of the kind of risky investment behaviour that we saw before the crash. He cites evidence, albeit anecdotal, that the crazy derivatives favoured by traders prior to 2008 are in heavy use and posing a distinct danger to the stability of world markets. He calls as evidence an interview in the Financial Times where Craig Parker, head of leveraged finance at Goldman Sachs, says: "We're in the third year of the greatest leveraged finance markets of all time because of the efforts by the Fed, and all the central banks around the world, to keep rates at zero."

Edwards believes there are signs of asset bubbles everywhere and the US, the UK and Japan are standing on the edge of a precipice, much as they did in 2006.

Making matters worse is the seductive charm of low interest rates for governments. Most western governments have borrowed heavily in the last four years. The UK has doubled its debt mountain and is still running a considerable annual budget deficit.

Public sector debt issuance as a proportion of GDP. Source: Datastream

Edwards reproduces a chart showing public sector debt issuance as a proportion of GDP in 17 key economies that puts Japan at the top with a startling figure of 58.4%. The US ranks third behind Italy with a total of 23.9%. The UK reaches 11th in the table with 12.1%.

The chart measures the amount of government debt that has matured this year and must be renewed. To some extent it merely shows the length of maturity on government bonds, and because the US has many more short-dated bonds than the UK, they therefore come up for renewal more often.

But the point Edwards is making needs to be recognised. Whatever each government's bond strategy, they are all relying on cheap borrowing for their newly minted debt.

In the UK's case, the Bank of England has been a major buyer and now owns around a third of the overall total. Without the central bank as a buyer, demand will be lower and the interest rate higher.

So quantitative easing and low interest rates are not only good for mortgage payers with big loans, investors who want to speculate with cheap money and banks that need to increase their reserves, it helps governments that need to borrow.

Sadly, bringing current spending under control is not a silver bullet when there is so much debt coming up for renewal, which is why finance ministers are tempted to just keep low rates rolling along forever, or at least until the middle distance.

Edwards argues that Japan is now in a situation where, like a junkie strung out on adulterated crack, it must keep pumping more and more into its system just to stay afloat (the junkie image is mine, by the way).

Edwards says of the UK: "Make no mistake, as a life-long Londoner I have never ever seen anything like the current frenzy. We are in the midst of the mother of all housing bubbles, and although the rest of the country has yet to follow, it inevitably will do so – it always does.

"The London housing bubble is no longer driven by Asian or eurozone buyers looking for safe havens. This bubble, like the one in the mid-noughties, is about excessively loose monetary policy and light touch regulation. No one should have any confidence the authorities will rein in this bubble. Indeed, quite the reverse. Getting house prices moving briskly upwards is the objective of monetary policy. And this is before the George Osborne's 'moronic' Help-To-Buy (votes …) scheme really begins to kick in."

It is hard to agree with Edwards' theory when evidence of reckless lending is hard to find, (see the Guardian video debate on the subject). The London market is dominated by cash buyers, foreigners and corporate interests, all of which can withstand higher interest rates (if they have a mortgage at all).

London is soaring and grabbing an greater slice of UK GDP, as set out by my colleague Aditya Chakrabortty. Yet there is no evidence that self-certified and 125% mortgages are back. In 2007 we had arrived at a point where a decade of booming house sales, some of them to people with no income or an uncertain ability to pay, had built up in the system. A crash of sorts was inevitable. Sure, left to its own devices, the UK property market will accelerate, there will be a bubble and the bubble will burst. Just give it five years.

Yet his wider argument, echoed by HSBC's chief economist Stephen King on the BBC Radio 4 show Analysis this week, that the global system is becoming unstable as QE distorts private sector and government behaviour, needs to be addressed openly by central banks and politicians alike.