13th June 2014
Bank of England governor Mark Carney has warned interest rates could rise ‘sooner than expected’, and the fall out for over-indebted households could be very serious.
Speaking at the annual Mansion house dinner in the City last night, Carney said that market speculation that rates will rise next year could be wide of the mark and that increases from the historic low of 0.5% could happen sooner.
‘There is already great speculation about the exact timing of the first rate hike…[but] it could happen sooner than markets currently expect,’ he said, although added the Bank’s Monetary Policy Committee (MPC) has no ‘pre-set course’.
Carney said any increase would be ‘data-driven’ and there was scope for other measures to be put in place before an interest rate hike.
While the Bank had said in its ‘forward guidance’ that rates would start to rise when unemployment dipped below 7%, it has fallen must faster than anticipated and growth has been much stronger. However, as wages have remained subdued despite an increase in jobs the Bank needs to exercise caution around how much and how quickly it increases rates.
‘Financial markets expect Bank rate to rise to only 2.25% over the next three years and, on that basis, the MPC expects the economy to move towards internal balance – almost closing the output gap – in the same period,’ he said.
Ben Brettell, senior economist at Hargreaves Lansdown, said Carney’s comments were a ‘U-turn’ on previous comments he has made on interest rate rises.
‘Throughout his tenure he has sought to convince markets that interest rates would remain lower for longer, but now he appears to be paving the way for a rate rise sooner than expected,’ he said. ‘These first hawkish comments have surprised economists and markets, with sterling strengthening close to five-year highs following Carney’s speech.’
Brettell said an increase in rates was a ‘positive sign’ as it meant the economy was strong enough to handle higher rates.
‘Not only would it be a signal that the Bank believes the economy is strong enough to withstand higher rates, but as process of slow, gradual increases could prevent the need for a sharper upward path should the economy continue to outperform expectations,’ he said.
Carney made it clear any interest rate rise would have to be carefully put into the context of homeowners who have burdened themselves with large mortgages, fuelled in part by the rapid rise in house prices.
‘A highly indebted private sector is particularly sensitive to interest rates,’ he said. ‘To be clear, the Bank does not target asset price inflation in general or house prices in particular. This is partly because over-extended borrowers could threaten the resilience of the core of the financial system since credit to households represents the lion’s share of the UK bank’s domestic lending.
‘It is also because rapid growth in or high levels of mortgage debt can affect the stability of the economy as a whole.’
While expanding the economy is an aim of the government and the Bank, Carney said it was ‘more precarious’ if there are a number of heavily indebted households as ‘history shows that British people do everything they can to pay their mortgages’, meaning they cut spending which slows the economy.
Worse to come
Currently, households have an average debt of 140% of disposable income that leaves the country in a ‘vulnerable position’, said Carney.
The situation is expected to worsen as rising house prices mean homeowners have to indebt themselves further to afford a home to live in. Carney said the proportion of loan-to-income for those taking out mortgages is at an all-time high.
‘The increase in house prices in the past year means we can expect the proportion of high loan-to-income mortgages to grow further in the coming year even if the housing market begins to slow,’ he said. ‘This is concerning because a durable expansion requires mortgages to be serviceable over their lifetime not just when interest rates are at record lows.
Chancellor George Osborne is trying to pre-empt this increase in high loan-to-income mortgages and last night he announced he has given the Bank’s Financial Policy Committee (FPC) new powers to curb mortgages on this basis.
The FPC, which already has the power to limit the Help to Buy scheme, will be given legal power to limit the amount of high loan-to-income mortgages banks can offer or the multiple allowed to be borrowed if it believes the property market is becoming a threat to the economy. It will also be allowed to go one step further and ban high loan-to-value mortgages if it sees fit.
While Osborne said there was ‘no immediate cause for alarm’ there are signs of future problems.
‘There are, on the horizon things that should give us some cause for concern,’ he said. ‘If London prices were to continue growing at these rates that would be too fast for comfort. And the rate of price rises is beginning to spread beyond London.’
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