Here’s a counterintuitive thought: might the Bank of England’s move today to clamp down on mortgage lending actually mean it ends up leaving interest rates at rock bottom for even longer?
That may very well be the upshot of the panoply of new measures unveiled by the Bank and its Financial Policy Committee this morning. And it won’t be the only way what happened today will affect you.
First off, let’s recap: the big news, as you may have gathered, is that the Bank is worried about where the mortgage market is heading. In its Financial Stability Review – a six-monthly survey of the risks facing the financial system, it pointed towards the recent increase in both house prices and mortgage lending.
These dynamics won’t be news to regular readers of this blog, however, the fact that the Bank now believes that rising mortgage debt levels are a threat to financial stability is a major development. Up until now it had maintained that rising house prices did not yet threaten to undermine the broader economy; as of today, it has appended rather more ominous titles to the same graphs (for instance on housing affordability) about which it seemed sanguine only a few weeks ago.
Moreover, its own in-house research suggests that households have become indebted in the past year – such that a fifth of households are now nursing mortgage debt worth five times their incomes. Our own research (based admittedly on an older vintage of the same data) suggests that the strain for households in London and the South is particularly heightened.
Which is where today’s measures come in.
First, the changes to Funding for Lending will mean there is less money sloshing into the mortgage market from banks. The FLS is a scheme whereby banks have been able to draw on cheap funding from the Bank of England in exchange for every pound they lent out to the UK economy. The original hope had been that it would boost lending to small businesses, but most analysis suggests that the vast impact has been felt in the mortgage market, where it has boosted the amount banks have lent out and pushed down the cost of borrowing. Right now, for instance, the average interest rate on UK mortgages is down at just over 3% – the lowest rate since comparable figures began in 1999.
As of January, Funding for Lending will no longer cover the mortgage sector. The Bank will also change capital rules so banks have to raise more capital (eg shares) if it increases mortgage debt. These two actions will make banks more reluctant to lend.
Second, the Bank is going to introduce a new power: in future, it wants more control over the tests individual high street banks carry out when they approve mortgages. At the moment, banks have to find out whether prospective borrowers would be able to afford their mortgage payments should interest rates rise to a certain level. In future, the Bank wants to be able to proscribe more specifically what this test level should be. In other words, if it sets the level at 5%, it will mean that you might not get your mortgage approved if you can’t prove you can afford your monthly payments if rates hit 5%.
These are both big, big moves. For those who are concerned about the direction the housing market was taking, they are pretty reassuring. They show that far from allowing a bubble to develop, the Bank is acting pre-emptively to try to clamp down on it. However, there will clearly be an impact: when the measures kick in, it will become considerably harder to borrow money for home purchase. The Government’s hope is that the Help to Buy scheme will mean that for some cash-strapped borrowers there is extra government help. But the reality is Help to Buy on its own was never going to have the power to supercharge the housing market – it’s a micro measure aimed at specific households. The real thing boosting mortgage activity in recent years was Funding for Lending. With that leg being kicked out from under the housing market it’s hard to see how there wouldn’t be a significant impact. The Governor’s insistence (in his letter to the Chancellor) that the change in the FLS won’t affect bank’s funding costs may well be right, due to comparatively generous new liquidity rules it’s brought in. However, what it doesn’t change is that the Bank is removing a key incentive aimed specifically at households.
So why does all of the above make it feasible that the Bank could leave borrowing costs unchanged for even longer? In short, it’s because interest rates are no longer the only lever the Bank has to try to influence the housing market. And for good reason: at present, the Bank is very concerned about the potential impact on household balance sheets if it were to raise interest rates.
A simulation some time ago (which is out of date now, and may actually be conservative) showed that if Bank rate went up to 4.5% it would push up the average household’s monthly mortgage costs to the highest level since the mid-1990s. The objective of today’s measures is to deter households from taking out debts they could not afford in the future. And if households are less indebted as a result, it may mean that the Bank doesn’t actually have to raise interest rates as quickly. Indeed, having seen today’s news, economists at Goldman Sachs said that if the Bank were to use these so-called “macroprudential” tools more actively, “it makes an early tightening in ‘conventional’ monetary policy less likely”.
We shall see. Either way, today’s developments are big news for any keen watchers of the housing market.