Most people in Britain must be looking forward to their holidays even more than usual this year. It has been a thoroughly miserable summer – and for many families, the weather has not been the only reason to dream of “getting away from it all”.

In the past 12 months, the single biggest item in almost every family budget – the cost of the mortgage – has increased more sharply than at any time in the past ten years. For every £100,000 borrowed – and the average new mortgage is now £126,500 – the interest costs have increased by £104 monthly. Meanwhile, the family earnings of £33,000 – which typically support every £100,000 borrowed – have grown by less than £20 per month, once increasing retail prices, unrelated to mortgage costs, are taken into account.

To put the point more directly, almost everybody in Britain is now substantially worse off than a year ago. In fact, the decline in real earnings, after taking account of inflation, mortgage costs and taxes, has been greater than at any time since the deep recession of the early 1990s. And most financial experts believe that the worst is still to come.

After the higher than expected inflation figures that were published on Tuesday, most City analysts believe that another increase, from 5.75 to 6 per cent, is now absolutely certain – and to judge by the recent trading in financial markets, further rate rises early in 2008 are more probable than not. To make matters worse, the big gains in property prices that have boosted homeowners’ wealth and thereby compensated for dwindling real incomes are probably a thing of the past. Average house prices outside London stopped rising last month, according to the Halifax index. And with interest rates marching ever upwards, they could soon start falling, at least for a while. Thus the normal recourse of the hard-pressed British family – to borrow recklessly against their valuable property assets – will look much less tempting in the coming months as house prices stagnate or fall.

That was the bad news. Now for something more optimistic. Most of what you read in the paragraph above should be taken with a large pinch of salt. Despite what you hear from City analysts and read in sensational newspaper headlines, there is nothing certain about another increase in interest rates. While it is true that incomes have recently fallen in real terms, the average British family is still far better off than it was a year ago because of the increase in its property, pensions and stock market wealth – and this favourable wealth effect will allow most people to keep borrowing to maintain their spending patterns, despite the squeeze on their real incomes. That, in fact, is how so many apparently hard-up families will be able to afford their foreign holidays this year, despite their declining real incomes and rising mortgage costs.

But doesn’t this mean their borrowing is reckless and imprudent? Not necessarily, even if we assume house prices stabilise or modestly decline in the year ahead, as suggested above. Most homeowners in Britain still enjoy a very comfortable cushion of equity in their property values and as long as this is the case they will be perfectly rational to borrow, in moderation, to go on holiday or buy a car or offset a temporary decline in real income. Only if interest rates keep rising or if house prices fall sharply, instead of just moving sideways, will the present pattern of borrowing in Britain become a cause for regret.

But isn’t the pincer movement of rising interest rates and falling house prices exactly the disaster that awaits the average British family when they return from their expensive holiday abroad? I don’t think so. In fact, I believe that the peak in interest rates may have been reached already, despite the strong consensus in the City which expects them to rise to 6 or 6.25 per cent. As for house prices, these may well decline slightly, but if I am right in assuming that interest rates will stabilise at or near current levels, a modest decline in house prices will do no serious damage to personal finances and wealth.

There are several reasons for this reassuring outlook – especially the recent extreme strength of the pound, which will squeeze large parts of the British economy and counteract a lot of the recent inflationary pressure – but the main reason for believing that interest rates will not rise much further is simple. The Bank of England disagrees with the City consensus about the inevitability of higher interest rates. How do I know this? Because the members of the Bank’s Monetary Policy Committee, who actually takes the decisions, keep saying so.

Mervyn King, the Governor of the Bank, has repeated time and again that the MPC never decides in advance on a strategy of raising interest rates in future months. Unlike the European Central Bank and the US Federal Reserve Board, the Bank of England genuinely decides on its monetary policy one month at a time. If the MPC really believed that interest rates inevitably had to be increased, they would have done this already. Or, at the very least, some of the members of the MPC would already have started arguing for a bigger increase in interest rates.

Yesterday morning, however, we learnt that the MPC was in fact debating the opposite course. Instead of voting unanimously in favour of last month’s rate increase to 5.75 per cent or arguing that interest rates need to rise to 6 per cent or even higher, three MPC members maintained that rates should remain at 5.5 per cent. That two of the three MPC dissenters were senior members of the Bank of England’s staff – Charles Bean, its chief economist, and Rachel Lomax, the deputy governor in charge of monetary analysis and research – strongly suggests that Bank’s own analysis puts the appropriate level of interest rates for the British economy today nearer 5.5 per cent than 5.75 per cent and certainly not higher.

This view may turn out to be wrong – I for one have argued that interest rates might need to rise to 6 per cent (although that was before the recent upsurge of sterling). But it is unlikely that the Bank will suddenly decide that its analysis was wrong by a very wide margin. The chances are, therefore, that interest rates in Britain are now at, or very near, their peak for the present cycle. So enjoy your holiday, even if you are travelling on borrowed money: you are unlikely to face bankruptcy when you return.

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