UK household debt at the end of March 2014 reached its highest level since 2009.Nick Barnes, Head of Research
The warning from Bank of England Governor Mark Carney at the recent Mansion House dinner that Bank Rate could rise earlier than anticipated - possibly by early next year – is likely to set alarm bells ringing in the housing market. This concern will be enhanced by the prospect of a cap on mortgage lending to be imposed at the discretion of the Bank of England, as announced by Chancellor George Osborne.
Leaving the aside the issue of timing, what would be the impact of a rise in Bank Rate? On the plus side, savings rates would improve and a stronger pound should have a deflationary effect as our imports would become cheaper. However, depending on the degree of the increase, the negative impact could potentially be significant and wide ranging.
Households and businesses alike would immediately feel the effect of increased borrowing costs, which could make them cut back on expenditure, which in turn could slow growth in the economy. Public debt interest payments would also become more expensive and the Government could seek to offset this by raising taxes or making further spending cuts – again, not good news for economic growth.
Sterling would likely receive a boost as speculators are attracted by the higher rates on offer, which would make our exports more expensive and would additionally make it more expensive for foreigners to buy property in the UK.
The housing market recovery, still fragile in many parts of the country outside London, could be compromised especially if a rise in Bank Rate were accompanied by a cap on mortgage lending. UK household debt at the end of March 2014 reached its highest level since 2009 according to the Office for Budget Responsibility (OBR) to stand at £1.574 trillion, around 89% of which was mortgage related. The OBR forecasts this figure will rise to £2.251 trillion by 2019 - a hefty 43% increase.
But what impact will a rise in interest rates have on the average household? We consider some hypothetical scenarios in the table below, assuming a repayment only mortgage in each case:
Source: Chestertons Research using Government data
Looking at the above figures, if rates were to double from their 2013 position, typical mortgage payments would increase from just over one fifth of average disposable monthly household income to just below 30%. Households will, of course, additionally need to service their non-mortgage related debt, the cost of which will also rise. It is worth remembering that our analysis does not allow for any increase in average monthly household income.
Increased borrowing costs for house builders, many of whom already struggle to secure finance for new projects, may force them to scale back on new development at a time when we desperately need more new houses. Any further worsening in the supply/demand ratio would only add inflationary pressure to house prices. Meanwhile, share prices for several major house builders had already dropped during the morning following Mr. Carney’s speech.
This leads us back to the issue of scale. The current thinking appears to be that an early small rate rise might remove the need for a larger hike further down the line. Recent history provides evidence of this approach: since January 2000, there have been 12 rises in Bank Rate – all of them by 25 basis points. However, a steady drip of several small increases over a relatively short period of time could build into a significant cumulative effect.
The immediate net effect of Mr. Carney’s announcement could be to delay buyers making a purchase decision. However, it might just persuade buyers hesitant about the shorter term direction of the market to buy now while they can still afford to. Cue a flurry of buyers looking for the best fixed rate deals they can find?