The Bank of England recently released its latest Financial Stability Report, emphasising the resilience of UK households and businesses in the face of continuously rising interest rates.
While acknowledging this resilience, the report also reiterates concerns about the impending full impact of higher interest rates on mortgage repayments and overall financial stability.
Over the past year, the Bank has incrementally increased its main policy rate 14 times, reaching a 15-year high of 5.25 per cent by August 2023. Despite these increases, the report notes that the majority of mortgages taken out in recent years were at fixed interest rates, causing a lag in the effects of higher rates on households.
Approximately 55 per cent of mortgage borrower accounts, totalling around five million, have repriced since the onset of rising interest rates in late 2021.
However, the report warns that an additional five million households are expected to be impacted by higher rates by 2026.
For a typical owner-occupier mortgagor transitioning from a fixed rate between April to June 2023 and the end of 2026, monthly mortgage repayments are projected to rise by around £240, representing a significant 39 per cent increase.
As these higher mortgage rates continue to affect households, the average debt servicing burden is expected to rise.
Governor Andrew Bailey reassured that the UK banking sector remains well-capitalised and has successfully weathered recent stress tests. He accentuated the sector's capacity to support households and businesses in the event of worsening economic and financial conditions. Bailey acknowledged that net interest margins, a key driver of bank profits, had likely peaked.
Despite higher mortgage costs, the report noted a positive aspect – a limited increase in home repossessions compared to historical patterns. Bailey attributed this to the improved capacity of the financial system to support borrowers, marking a significant benefit of enhanced financial stability.
However, Bailey highlighted an increase in arrears among homeowners, both those with mortgages and buy-to-let landlords. He expressed concern about the growing proportion of renters, especially considering the decline in home ownership, as they tend to be on the lower end of the income scale. The issue of arrears is particularly scrutinised through the lens of the buy-to-let market.
Sarah Breeden, the deputy governor responsible for financial stability, discussed how some borrowers are responding to higher mortgage rates. She noted a rising trend of long-dated mortgages, particularly among younger borrowers, with terms of up to 35 years.
Breeden also expressed attention towards lending into retirement, emphasising the need to monitor the potential strain on income for mortgage payments in later years.
In the corporate sector, evidence of arrears was observed, especially among small and medium-sized businesses. However, the report indicated a decrease in the share of corporates at higher risk compared to the pandemic peak. The bulk of UK corporate debt on fixed rates is set to mature in or after 2025, leading the Bank to judge that the UK corporate sector as a whole has remained resilient.
Looking beyond the UK, Governor Bailey highlighted the overall challenging risk environment, singling out the Chinese economy as a particular global risk, with various parts of the property sector still under strain. He also noted geopolitical uncertainties stemming from tragic events in the Middle East.
The report highlighted concerns about vulnerabilities in 'non-bank' finance, such as loans and credit provided by institutions other than traditional banks. Market-based finance, including high-yield bonds and leveraged loans, was specifically highlighted as an area where risks remained significant and, in some cases, had increased since the Bank's previous report in July.
Governor Bailey raised a cautionary note about larger imbalances in the market in derivatives for US government debt, stressing the potential for market volatility if hedge funds needed to rapidly unwind their positions in such instruments. He drew attention to the risk of wider dislocations, referencing the LDI crisis following Kwasi Kwarteng's mini-budget in September of the previous year.
The report also revealed that the Bank's financial policy committee had been briefed on the continued adoption of artificial intelligence (AI) and machine learning in financial services. While acknowledging the potential benefits of AI in improving productivity, Bailey emphasised the complexity of the code behind it and the need for understanding.
In a final note, Governor Bailey paid tribute to Alistair Darling, the former Chancellor, who passed away recently, describing him as wise, kind and possessing a wicked sense of humour.
