BOE's Cunliffe Warns Buy-to-Let Could Amplify Housing Shocks

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  • Sharp price movements, rate rises may cause investors to exit
  • Case for changing capital tool earlier rather than later

Bank of England policy maker Jon Cunliffe said the reaction of buy-to-let investors to higher interest rates or falling prices could "amplify an adverse shock to the housing market."

“It is not in my view at all impossible that sharp movements in prices and a loss of confidence in future capital appreciation, in combination with interest-rate increases, could cause a substantial number of buy-to-let landlords to seek to exit the market,” Cunliffe, deputy governor for financial stability said in prepared remarks for a speech late on Tuesday in Geneva. "This could put material downward pressure on house prices.”

The BOE, which is charged with ensuring financial stability in the U.K., is concerned by growth in so-called buy-to-let lending and is ready to restrict loans to landlords if necessary, BOE Governor Mark Carney said in an interview last week. With annual house-price growth at 9.6 percent in London in September, economists at UBS Group AG have warned that demand from investors raises a risk of a substantial fall in values in the capital.

“It is not clear how buy-to-let investors will behave when interest rates go up or if house price growth moderates,” Cunliffe said. “The greater initial equity in buy-to-let may mean that investors are more resilient to small falls in house prices and higher servicing costs than owner occupiers. But they may prove more vulnerable to larger falls in house prices and increases in rates that stretch their rental cover.”

FPC Challenges

The stock of U.K. mortgage lending for buy-to-let increased to 200 billion pounds ($302 billion) from 65 billion pounds in the past decade and is growing by about 9 percent a year, Cunliffe said. The loans represent 16 percent of all mortgages and accounted for 80 percent of net lending over the past year. Demand for buy-to-let lending rose the most in at least three years in the third quarter, according to a Bank of England survey of lenders.

Cunliffe focused much of his speech on the challenges facing the bank’s Financial Policy Committee, which uses so-called macroprudential tools to tame risks to stability, as the Monetary Policy Committee prepares to raise the key interest rate from the current record-low 0.5 percent. Officials will need to sharpen their assessment of how the U.K.’s move to a "more normal phase" of the credit cycle raises stability risks, he said.

"As we move forward in the credit cycle, I think we will need to consider whether and how risks are building in the financial system and how they should be addressed," he said. "This is of course already a regular and important element of the FPC’s discussions. But my guess is that it will become even more so in the next phase of the cycle."

Tail Risks

There are a variety of approaches the BOE can take. One is to ensure that tail risks don’t increase with the credit cycle. There’s also the prospect that officials could explicitly push back until the amount and composition of credit are more acceptable, something they did last year when the bank set loan-to-income limits on certain risky mortgage loans.

Such an approach is a bigger decision than targeting financial resilience, he said. "But given the history and the objective of maintaining financial stability, I do not think that the macroprudential authority can foreswear making such calls when necessary."

Cunliffe also said there was an argument for officials to raise the so-called countercyclical capital buffer, which banks build up in good times to run down when times are tough, "earlier rather than later in the cycle.” This may be needed to address a potential lag in its impact, and give officials room to cut if needed to boost credit. That case is also supported if officials believe risks are building or that are benefits to moving policy gradually, he said.