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The BoE outlook and implications for mortgage lenders

by Sable International | Aug 15, 2014
  • At the August Monetary Policy Committee (MPC) meeting, the Bank of England (BoE) left the benchmark rate fixed at a record low of 0.5%. Rates at the BoE have been stable at that level since March 2009, and it is worth pointing out that this is the longest period during which the rate has remained unchanged since the end of World War 2.
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    This extended period of low and stable interest rates has been a comfort to indebted consumers, specifically those holding mortgages. Furthermore, given the constrained economic outlook, which resulted in the 0.5% rate back in 2009, home buyers have enjoyed a high degree of confidence that rates would remain subdued for an extended period of time.

    However, as we move further into the latter half of 2014, economic indicators suggest a bias toward a BoE monetary policy adjustment. Although July saw a dip to 55.4 on the manufacturing Purchasing Managers Index (PMI), a closely monitored indicator of the sector, there has been expansion within the industry for the past 17 months. What's more, the number printed in June was the second-highest reading in over three years, bettered only by the reading seen last November. 

    The services sector similarly remains within expansionary territory, as measured by the equivalent index, climbing to the highest level since November last month. The BoE remains optimistic, upwardly revising its full year growth forecast for 2014 to 3.5% from 3.4% at the latest quarterly inflation report.

    From a labour market perspective, the June figures from the Office for National Statistics (ONS) showed that the unemployment rate fell to 6.4%, the lowest level in five years. However, this has not been associated with the noticeable rise in wage growth which increased by just 0.6%, excluding bonuses, over the same period. This is the slowest increase since 2001 and well below the June inflation reading (as measured by CPI) at 1.9%.

    This remains a concern amongst policy makers and in the latest BoE quarterly inflation report, Governor Carney suggested that the bank was watching wage growth very closely given the effect that rising rates could have on expenditure adjustments. In addition to this, Carney pointed to the subdued growth in wages as an indication that there remains some “slack” within the economy. The argument for excessively loose monetary policy has been justified by the level of capacity underutilisation, and thus rate hike expectations may be pushed out along the curve following these comments. 

    However, it is notoriously difficult to measure economic potential and the Bank did downwardly revise its assessment of excess capacity to just 1%. This would suggest that there are likely to be more MPC members inclined to vote for a rate hike going forward. Perhaps the only conditionality on this would be a more pronounced rise in wage growth.

    Whilst it is not the purpose of this article to speculate about the timing or extent of potential rate hikes, as economic data continues along the recent trend, the bias remains tilted toward an adjustment to the upside. In line with this, it is worth demonstrating the extent to which the market is increasingly positioning itself for such a move.

     This can be illustrated using the UK gilt yield curve. Given the liquidity and volume traded on the market, the gilt curve is a strong indication of market interest rate expectations. It is important to note the rise in shorter dated rates over the past six months. Whilst the move on the 1yr rate has been muted, the 2yr rate has risen close to 30 basis points over the same period, with stark implications for lenders within the retail environment.  

    The bottom line is that whilst the timing, or even certainty of a BoE rate hike, remains unclear, market players are pricing in the event and this has important implications for the mortgage industry. As lenders need to price their products in line with the funding available to them within the broader market, concerns of a BoE rate hike will force the hand of mortgage lenders. This is a trend which we have already witnessed as banks attempt to hedge out interest rate risk, the price of fixed rate mortgages increase. In line with this, many banks have already upwardly adjusted stress test rates in an effort to shield themselves from customers who would not be able to afford interest rate increases, further signalling that lenders are positioning themselves for the inevitable.  

    Holding a tracker mortgage has held plenty of benefit in recent years, given the heightened level of certainty that rates would remain anchored. However, even if you remain uncertain as to when, or even if, the BoE will hike rates, the ability to lock in a fixed rate and hedge yourself against an interest rate adjustment is becoming increasingly expensive. Thus when one considers the current economic trend, it is a good time to re-examine exposure to interest rate risk. The comfort and stability of record low rates in recent years is set for a shake-up and as the market positions itself for adjustments, the prudent individual investor should look to do the same.    

    For more information, contact us on +44 (0) 20 7759 7519 or email wealth@sableinternational.com.

    We are a professional services company that specialises in cross-border financial and immigration advice and solutions.

    Our teams in the UK, South Africa and Australia can ensure that when you decide to move overseas, invest offshore or expand your business internationally, you’ll do so with the backing of experienced local experts.

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