Bank of England Governor Mark Carney can’t get away from the housing market.
As he argues there is no immediate need to raise interest rates, central to his case is the mountain of debt financing property. Home loans account for almost 90 percent of the 1.45 trillion pounds ($2.3 trillion) owed by U.K. households. In London, where the average home costs 500,000 pounds, first-time buyers are paying almost nine times their annual income to get onto the housing ladder.
Such figures explain why Carney says rate increases when they come will be “gradual and limited.” Testifying to lawmakers in London today, he highlighted the risk that heavily indebted households could curtail spending if borrowing costs are raised too aggressively. With inflation continuing to outstrip pay, Britons may find it hard to ease the burden anytime soon.
“A small increase in interest rates will cause serious debt-servicing problems in the U.K., including London,” said Ismail Erturk, a senior lecturer on banking at Manchester Business School. “The current economic recovery in the U.K. is based on shifting sands, because it doesn’t improve wages.”
While U.K. debt as a percentage of gross disposable income has fallen from around 170 percent in 2007, it’s still at about 140 percent, the highest in the Group of Seven after Canada. Mortgage debt has risen by about 90 billion pounds since then.
Halifax, the mortgage unit of Lloyds Banking Group Plc, estimates a 100-pound jump in monthly home-loan payments could force almost 40 percent of London mortgagees to pare spending on essentials including food and clothing.
Values in the capital are more than a third above their previous peak in 2008 and double the national average. They surged 19 percent in the year through June, twice as fast as the U.K. as a whole, Office for National Statistics data show.
“These extraordinary rates of house-price growth cannot continue in the current, more regulated mortgage environment, particularly in the face of likely interest-rate rises,” said Lucian Cook, head of residential research at broker Savills Plc.
Britain is vulnerable to interest-rate shocks because about two thirds of outstanding mortgages are at rates that move with the BOE benchmark. In the U.S., the figure is little more than a tenth, according to the Washington-based Mortgage Bankers Association.
The mortgage increase that Halifax warned would hurt London households is about the equivalent of a 0.5 percent rate increase. That’s for an average home bought using a 25-year mortgage charging 3 percent, with a 20 percent down payment.
“It has to be of concern that such small changes can have such large impacts on core items of expenditure,” said Julian Sinclair, chief investment officer at Talisman Global Asset Management Ltd., which oversees 2.5 billion pounds of equities, credit and private lending.
With the average first-time buyer mortgage climbing above 200,000 pounds this year, Britons are having to borrow for longer periods. About a quarter of new mortgages last year were for 30 years or more, compared with 15 percent in 2007, according to the BOE.
Carney’s attempt to reassure consumers and businesses that the BOE benchmark will peak well below the 5 percent seen before the financial crisis has helped to hold down borrowing costs. Five-year gilts are yielding 1.77 percent today compared with 1.86 percent at the end of last year. Traders are betting the BOE will refrain from raising the 0.5 percent benchmark until June, and then only increase it to 2 percent by 2018, Sonia forwards show.
Financial-stability officials have taken some action to prevent an unsustainable debt buildup, toughening affordability checks in April and then restricting the proportion of mortgages at 4.5 times income to no more than 15 percent of new home loans.
“They’ve picked out this 4.5 times loan-to-income multiple from thin air because it’s one of the few measures where you’re not through the previous peak substantially,” Sinclair said.