Photographer: Matthew Lloyd/Bloomberg

U.K. Braces for Rate Increase Never Experienced by Young Debtors

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After more than six years of record-low interest rates, the looming increase hinted at by Bank of England policy makers may come as a shock to consumers driving Britain’s recovery.

As Governor Mark Carney signals that rates could rise early next year, officials are weighing the potential costs for the fastest-growing economy in the Group of Seven. A risk is that highly indebted households curtail their spending, putting the brakes on an expansion getting no help from exports.

For many people under the age of 30, the increase will be the first of their working lives. The BOE has held its benchmark at 0.5 percent since March 2009, helping to fuel a housing boom that has left Britons owing a record 1.5 trillion pounds ($2.3 trillion). The key rate averaged 4.5 percent in the preceding six years.

“I would expect the economy to be more sensitive to a 25 basis-point rise than in the past, since the level of household debt in the economy is still relatively high,” said David Tinsley, an economist at UBS Group AG in London. “There’s a segment of the household sector whose perceptions of a normal rate of interest is conditioned to be very low.”

One such person is Naomi Scott-Mearns, a 23-year-old environmental consultant who is saving to buy a home in London.

‘Real Concern’

“I think rates will rise within the next few years,” she said. “It is a real concern for people having to consider an interest-rate rise. I think some people will have to scale back spending.”

At more than 140 percent of income, the debt burden of British households is higher than in the U.S., Germany and France, and government forecasters see it rising to almost 170 percent by 2020. BOE financial-stability officials estimate about 5 percent of households have debts equal to four times their income or more.

A rate increase would immediately push up the cost of variable-rate mortgages, which account for almost 60 percent of outstanding homes loans. The preference for fixed-rate loans in recent years may offer little respite as many are on short terms, according to Societe Generale SA economist Brian Hilliard.

While most personal indebtedness is made up of mortgages, unsecured debt such as credit-card borrowing is growing at about 8 percent annually and on course to reach 10,000 pounds per household by the end of 2016. Total debt costs would rise by 1,000 pounds a year if interest rates increase by 2 percentage points, Pricewaterhouse Coopers estimated in a report in March.

BOE Action

The dangers are not lost on the BOE, which took action last year to stop people taking on debt they may eventually struggle to afford. Carney insists rates will go up gradually and peak below pre-crisis levels. Money markets are barely pricing in a benchmark rate of 1 percent by September next year.

For some economists, the longer the BOE delays, the bigger the shock will be to households when policy is tightened
For some economists, the longer the BOE delays, the bigger the shock will be to households when policy is tightened
Simon Dawson/Bloomberg

The nine-member Monetary Policy Committee is meeting this week against a backdrop of a firming labor market and the longest stretch of continuous economic expansion since before the financial crisis. That could lead a minority to vote for an interest-rate increase.

“We look for three MPC members to have voted for a 25 basis-point hike this time, ahead of an eventual November hike as momentum in wage growth continues,” said Sue Trinh, a currency strategist at RBC Capital Markets.

Rising living standards could help insulate consumers from rate increases. Wage growth accelerated at the fastest pace in more than five years in May, while inflation is zero.

Debt Burden

“Borrowers that are up-to-date on their payments will be able to adjust their discretionary spending if incremental rate rises are spread out over the next three years,” said Emily Rombeau, an analyst at Moody’s Investors Service.

Britain’s reliance on the willingness of consumers to keep spending was underscored by a survey Monday showing that manufacturing remained all but stagnant in July as export demand fell for a fourth month.

For now, the burden of personal debt remains manageable as lenders compete for market share by cutting rates to all-time lows. First-time buyers are losing just over a third of their take-home pay to mortgage payments, compared with more than a half when the BOE last raised interest rates, to 5.75 percent, in July 2007, according to Nationwide Building Society.

For some economists, the longer the BOE delays, the bigger the shock will be when policy is tightened.

“A rate rise should be relatively prompt, and relatively steady,” said Philip Shaw, an economist at Investec Securities in London. “There’s a general level of uncertainty, given that we’ve not had a rate increase for so long.”

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