The Bank of England has said that UK households and businesses have been “resilient” in the face of rising interest rates – but repeated previous warnings that the full effect of higher interest rates was yet to come through.
Unveiling its latest Financial Stability Report – which is published twice yearly – the Bank said that household finances remained “stretched by increased living costs and higher interest rates, some of which has yet to be reflected in higher mortgage repayments.”
The Bank, which raised its main policy rate 14 consecutive times between December 2021 and August this year to the current 15-year high of 5.25%, said that, because most mortgages taken out over recent years had been at a fixed interest rate, higher interest rates tended to have a lagged effect on households with a mortgage.
It said that around 55% of mortgage borrower accounts, around five million, had repriced since interest rates began to rise in late 2021.
But it warned: “Higher rates are expected to affect around five million [further] households by 2026.
“For the typical owner-occupier mortgagor rolling off a fixed rate between [April to June] 2023 and the end of 2026, their monthly mortgage repayments are projected to increase by around £240, or around 39%.
“As higher mortgage rates continue to flow through to UK households, the average debt servicing burden will increase.”
The report noted that, although average quoted mortgage rates had come down since the Bank’s last Financial Stability Report in July this year, they remained “higher than in the recent past”.
Andrew Bailey, the governor, emphasised that the UK banking sector remained well capitalised and had come through the Bank’s recent stress tests well.
He added: “If economic and financial conditions were to materially worsen for households and businesses, our banking sector has the capacity to support them.”
He said that there was evidence that net interest margins (the spread between what banks charge borrowers and pay depositors and a key driver of bank profits) had peaked.
The governor highlighted that, “thank goodness”, despite higher mortgage costs there had not been a big increase in home repossessions as in the past.
He added: “The financial system is much better placed to support borrowers. It’s a benefit of financial stability that the system is able to take these actions. And that’s a good thing, a very good thing.”
Mr Bailey said that, while UK households and businesses had remained resilient in the face of higher borrowing costs, the Bank had noticed an increase in arrears among home owners – both those living in their own homes with a mortgage and among buy-to-let landlords.
He said that the Bank was “very alert” to the issue of renters and particularly in view of the fact that, with home ownership in decline, renters now formed a larger proportion of the population and also tended to be at the lower end of the income scale.
He went on: “There is obviously a financial stability lens on this and it comes through the buy-to-let market.”
Asked about the way in which some borrowers were responding to higher mortgage rates Sarah Breedon, the deputy governor responsible for financial stability, said the Bank had noted an increased uptake, over time, of long-dated mortgages of up to 35 years and particularly among younger borrowers.
She added: “The more important thing is lending into retirement when people might not have the income [to cover mortgage payments]. We don’t judge it as a financial stability risk but it is something we are watching.”
Mr Bailey said that, among corporates, there was also evidence of some arrears building up and in particular among small and medium sized businesses.
But the report noted that the share of corporates at higher risk had fallen from its pandemic peak and pointed out that the bulk of UK corporate debt on fixed rates was due to mature in or after 2025.
The governor added: “We judge that the UK corporate sector as a whole has remained resilient.”
Further afield, Mr Bailey said that the overall risk environment remained challenging, singling out the Chinese economy – where many parts of the property sector remain under strain – as a particular risk for the global economy. He added that the “tragic events in the Middle East” had also contributed to geopolitical uncertainty.
The governor also sounded a warning on vulnerabilities in so-called ‘non-bank’ finance – services such as loans and credit which are not provided by banks but by other institutions, such as insurers, venture capital firms and currency exchanges.
In particular, he highlighted market-based finance – the provision of types of corporate credit, such as high-yield bonds and leveraged loans – where he said risks remained significant and, in some cases, had increased since the Bank’s last report in July.
He added: “There are now larger imbalances in the market in derivatives for US government debt – a key instrument in the financial system.”
The governor said that this could contribute to market volatility if hedge funds needed to unwind their positions in such instruments rapidly and noted that sharp movements in the prices of such assets could lead to wider dislocations as was shown during the LDI crisis which followed Kwasi Kwarteng’s mini-Budget in September last year.
The report also revealed that, since July, the Bank’s financial policy committee had been briefed on the continued adoption of artificial intelligence and machine learning in financial services and their potential financial stability implications.
Mr Bailey said: “I don’t pretend to be an expert on AI, because I am not, but when I speak to people who are they make the point [on] the complexity of the code behind it and the extent to which it is understood.
“It obviously has tremendous potential and particularly to improve productivity which would be a welcome thing.”
The governor also paid tribute to Alistair Darling, the former Chancellor, who died last week. He said Lord Darling was “wise, kind and had an absolutely wicked sense of humour.”