The key chart
Share of UK HHs with mortgage COLA-DSRs above 70% (Source: BoE Financial Stability Review, July 2023)
The key message
How high would the UK base rate have to increase for HH debt vulnerabilities to return to GFC levels? To around 9% according to the Bank of England today, up from a broader, estimated range of 5-8% indicated a year ago…
The Bank of England (BoE) held a press conference regarding its July 2023 Financial Stability Review (FSR) this morning (12 July 2023). As always, the question and answer session was particularly important not least in the request for clarification on rising HH debt vulnerabilities.
Recall that a year ago, Sir Jon Cunliffe, the Deputy Governor for Financial Stability, was asked for clarification on this topic – how far would interest rates have to rise for HH debt vulnerabilities to reach the GFC peak levels?
In response, he indicated that rates would have to rise by between 200-500bp above the existing market expectations. These were 3% at the time. In other words, the base rate would need to return to between 5% and 8% for debt vulnerabilities to return to the GFC levels. Today’s UK base rate is 5%, at the bottom end of this range.
In the latest FSR, the Bank of England returned to this topic. The Bank stated that, “The proportion of HHs with high mortgage cost-of-living-adjusted debt-servicing ratios (COLA-DSRs) is expected to continue to increase [from 2% in 1Q23] to around 2.3%…by the end of the year. But it would stay below the recent peak reached in 2007 of 3.4%.” (see key chart)
Importantly, the report then notes that, “To reach that peak level by the end of 2024, it would require mortgage rates to be around three percentage points higher relative to current expectations [c.6%], other things being equal.”
In short, the BoE has narrowed the range and increased the level of the base rate that would lead to a return of GFC levels of HH debt vulnerabilities – to 9%.
The main reason, according to Sir Jon Cunliffe, is the level of support provided by banks in terms of extending mortgage terms, changing mortgage terms and supporting moves to interest-only mortgage. In other words, more options and support from banks has given slightly more “breathing room” before debt vulnerabilities return to their recent 2007 peak.
A year ago, I felt that the BoE was verging on complacency in terms of rising HH debt vulnerabilities. Ninety days later the tone of the message changed and higher risks acknowledged. Today, we have a narrow and clearer “risk target” but the body language was less-than-convincing, in my opinion.