Heavily indebted homeowners will be hit hard if interest rates start to rise before wages have picked up, according to research by the Bank of England that underlines the dilemma facing policymakers as the economy recovers.
Amid speculation that borrowing costs may have to increase sooner than expected as unemployment falls and the housing market picks up, the Bank's study, published in its Quarterly Bulletin, suggests rate-setters will have to tread carefully.
The findings come as fresh evidence emerges of the renewed strength of the housing market, with the Council of Mortgage Lenders reporting a 30% increase in mortgage lending in the year to November.
Drawing on a detailed survey conducted by consultancy NMG, the Bank finds that average household debt remains high, at £87,000, and any rate rise that was not accompanied by an increase in real wages could push a growing proportion of borrowers close to the edge.
"Higher interest rates would increase debt-servicing costs for households, but the extent to which that may pose problems for households in the future will depend on how much incomes increase before rates rise," it says.
If interest rates were lifted to 3% from their current record low of 0.5%, it would almost double the proportion of those the Bank calls "vulnerable mortgagors" – those forced to spend at least 35% of their pre-tax income on repayments – to 16%, unless incomes had risen in the interim.
Even if incomes have jumped by 10% by the time rates reach 3%, the study shows, the proportion of vulnerable borrowers would still increase by half, to 12%.
Almost half of mortgage-borrowers said that a rate rise on this scale – to 3% – would force them to take action of some kind. requesting longer working hours, for example, in order to afford the higher repayments, unless their wages had also gone up.
Bank governor Mark Carney has stressed that he will leave interest rates on hold at least until the unemployment rate falls below 7%, something the Bank doesn't expect to happen until at least 2015.
But with the jobless rate falling faster than expected, hitting 7.4% in the three months to October, City investors are speculating that policy may have to be tightened sooner.
Matthew Whittaker, senior economist at thinktank the Resolution Foundation, said the impact of rising rates would also depend on whether more generous wage deals were widely spread, or concentrated among higher earners.
"The really tricky bit for the Bank of England is if you start to get rising inflationary pressure because of spending by affluent people, but people at the bottom who still haven't dealt with the debt hangover from the good years don't see any real income growth."
The latest research will help to support the argument that rushing to a rate rise could have damaging consequences. Frances O'Grady, general secretary of the TUC, said: "Household budgets remain under immense strain and any upward move in interest rates could be enough to tip many families over the edge."
Carney has stressed that he does not think interest rates should rise simply in order to tame the housing market: instead, he sees the Bank's new Financial Policy Committee as the first line of defence against overheating property prices.
The FPC has already cancelled the element of the Bank's Funding for Lending Scheme which supported cheap mortgage borrowing, and it could demand that banks hold more capital against mortgages if it believes a bubble is starting to inflate.
However, the Treasury is pressing ahead with its Help to Buy scheme, which will offer taxpayer-backed mortgage guarantees to borrowers who can only raise a small deposit.
In a separate article in today's Quarterly Bulletin, the Bank shows that small businesses could also be vulnerable to rising interest rates, unless economic conditions have improved in the meantime.
The Bank's economists have investigated the phenomenon of "forbearance", under which banks have tended to give distressed business borrowers an easy ride during the crisis, rather than forcing them into default.
In total, the study found that around 6% of small- and medium-sized business borrowers, representing 14% of banks' exposure to the sector, were "in receipt of some form of loan forbearance" in 2013.
The Bank does not believe these "zombie firms", as they are sometimes known, are jeopardising financial stability, and it argues that while propping up firms instead of letting them go bust could lead to a misallocation of resources across the economy, it is unlikely to be the explanation for much of the collapse in productivity in the UK since the crisis.
However, the researchers warn that the extent of forbearance means some small firms would be in danger if rates rise too soon. "Results from this investigation suggest that firm default rates could increase in response to a rise in interest rates, especially if not accompanied by an improvement in economic conditions," it said.
theguardian.com
Amid speculation that borrowing costs may have to increase sooner than expected as unemployment falls and the housing market picks up, the Bank's study, published in its Quarterly Bulletin, suggests rate-setters will have to tread carefully.
The findings come as fresh evidence emerges of the renewed strength of the housing market, with the Council of Mortgage Lenders reporting a 30% increase in mortgage lending in the year to November.
Drawing on a detailed survey conducted by consultancy NMG, the Bank finds that average household debt remains high, at £87,000, and any rate rise that was not accompanied by an increase in real wages could push a growing proportion of borrowers close to the edge.
"Higher interest rates would increase debt-servicing costs for households, but the extent to which that may pose problems for households in the future will depend on how much incomes increase before rates rise," it says.
If interest rates were lifted to 3% from their current record low of 0.5%, it would almost double the proportion of those the Bank calls "vulnerable mortgagors" – those forced to spend at least 35% of their pre-tax income on repayments – to 16%, unless incomes had risen in the interim.
Even if incomes have jumped by 10% by the time rates reach 3%, the study shows, the proportion of vulnerable borrowers would still increase by half, to 12%.
Almost half of mortgage-borrowers said that a rate rise on this scale – to 3% – would force them to take action of some kind. requesting longer working hours, for example, in order to afford the higher repayments, unless their wages had also gone up.
Bank governor Mark Carney has stressed that he will leave interest rates on hold at least until the unemployment rate falls below 7%, something the Bank doesn't expect to happen until at least 2015.
But with the jobless rate falling faster than expected, hitting 7.4% in the three months to October, City investors are speculating that policy may have to be tightened sooner.
Matthew Whittaker, senior economist at thinktank the Resolution Foundation, said the impact of rising rates would also depend on whether more generous wage deals were widely spread, or concentrated among higher earners.
"The really tricky bit for the Bank of England is if you start to get rising inflationary pressure because of spending by affluent people, but people at the bottom who still haven't dealt with the debt hangover from the good years don't see any real income growth."
The latest research will help to support the argument that rushing to a rate rise could have damaging consequences. Frances O'Grady, general secretary of the TUC, said: "Household budgets remain under immense strain and any upward move in interest rates could be enough to tip many families over the edge."
Carney has stressed that he does not think interest rates should rise simply in order to tame the housing market: instead, he sees the Bank's new Financial Policy Committee as the first line of defence against overheating property prices.
The FPC has already cancelled the element of the Bank's Funding for Lending Scheme which supported cheap mortgage borrowing, and it could demand that banks hold more capital against mortgages if it believes a bubble is starting to inflate.
However, the Treasury is pressing ahead with its Help to Buy scheme, which will offer taxpayer-backed mortgage guarantees to borrowers who can only raise a small deposit.
In a separate article in today's Quarterly Bulletin, the Bank shows that small businesses could also be vulnerable to rising interest rates, unless economic conditions have improved in the meantime.
The Bank's economists have investigated the phenomenon of "forbearance", under which banks have tended to give distressed business borrowers an easy ride during the crisis, rather than forcing them into default.
In total, the study found that around 6% of small- and medium-sized business borrowers, representing 14% of banks' exposure to the sector, were "in receipt of some form of loan forbearance" in 2013.
The Bank does not believe these "zombie firms", as they are sometimes known, are jeopardising financial stability, and it argues that while propping up firms instead of letting them go bust could lead to a misallocation of resources across the economy, it is unlikely to be the explanation for much of the collapse in productivity in the UK since the crisis.
However, the researchers warn that the extent of forbearance means some small firms would be in danger if rates rise too soon. "Results from this investigation suggest that firm default rates could increase in response to a rise in interest rates, especially if not accompanied by an improvement in economic conditions," it said.
theguardian.com
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