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Bank of England
Financial Policy Committee
Verum Financial Research
unsustainable household debt
A new consumer credit report published by independent research company Verum Financial Research says that UK houses are currently overpriced by around 28% and that unsustainable mortgage debt is already at such levels that there is a serious risk of the UK falling back into recession.
Verum describe the UK’s recovery as ‘extremely fragile’ reporting that for every 0.5% increase in the Bank of England base rate, household spending would be reduced by £4.8bn and if the base rate increased to 3%, that would be enough to tip the balance and plunge the nation into another downturn.
Professor James Fitchett of Leicester University School of Management comments in the foreword to the report: "The main problem facing the UK economy is therefore now a problem concerning consumer spending and debt. As these data show in considerable detail, the prospect of even slightly higher marginal lending rates could have a catastrophic effect on the economy."
House Prices Disproportionate to Earnings
According to the Verum report, total household debt increased by 314% from £347bn in 2013 of which 89% was mortgage debt. House prices increased by 318% over the same period, while household incomes have risen by only 203%.
"This elevated level of mortgage debt is unsustainable. In a stable housing market, house prices should grow at the same rate as household incomes so that periodic ‘booms and busts’ are avoided," said Robert Macnab, Verum’s director of research.
"So unless wages increase quickly, which is unlikely, our analysis of the relationship between household incomes, debt and property prices indicates that UK house prices are currently over-valued by 28%. The average should be nearer to £180,000 and not £250,000 as it is at present."
The ‘debt-spiral’ that now threatens the economy is compounded by the increased cost of living which, combined with a real terms drop in income, is restricting the ability of households to reduce debt.
Spiralling Debt will Drag Down Economy
"With household finances under such pressure, any rise in the abnormally low interest rates will have a negative impact on consumer spending," continues Robert Macnab. "Our research has identified an important threshold when 12% of household disposable income goes to servicing debt interest payments. At this level households cut back significantly on discretionary and often credit-sensitive purchases such as vehicles, holidays, durable goods and furniture, a scenario that would bring the recovery to a grinding halt. To reach this 12% threshold, base rates would only need to rise to 3%. If mortgage rates followed suit, which they invariably do, the housing market would experience a sharp correction."
The Verum reports comes on the back of the Bank of England’s inflation report delivered by Mark Carney, the bank’s governor last week. He said that the booming housing market represented the "biggest risk" to financial stability and the long term recovery.
However, the increasing disparity between house prices and incomes represents the biggest threat to the economy as households start to buckle under the strain of household debt in a recovering economy.
Mark Carney has given the Financial Policy Committee (FPC) until June 17th to decide which tools to implement that will slow down the housing boom. Those recommendations are likely to include increased capital requirements for lenders and a further tightening of affordability tests for borrowers.
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