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The Bank of England (BoE) introduced new measures last week to cap household indebtedness caused by an overheated UK property market and soaring mortgage lending although analysts and housing professionals remained unimpressed.
The Financial Policy Committee (FPC), the financial stability watchdog of BoE said that lenders will not be allowed to lend any more than 15% of residential mortgages at more than 4.5-times a borrower’s income.
What remains at the moment a ‘recommendation’ applies to all lenders extending residential mortgage lending in excess of £100m annually with the rules to be enforced on 1st October 2014.
According to the FPC report, the recovery in the British housing market has been associated with a marked rise in the share of mortgages extended at high loan to income (LTI) multiples. At higher levels of indebtedness, households are more likely to encounter payment difficulties in the face of shocks to income and interest rates, potentially posing direct risks to the resilience of the nation’s banking system as well as indirect risks via its impact on economic stability.
The FPC does not believe that household indebtedness poses an imminent threat to stability but has nevertheless agreed that it is prudent to insure against the risk of any loosening in underwriting standards which would result in a significant increase in the number of highly indebted households.
Senior adviser to economic forecasters the EY ITEM Club, Martin Beck commented: “The direct effect of the FPC’s announcements in cooling the house market is likely to be limited. As high LTI mortgages account for only 10% of the total, there is still sizable room for such lending to expand before the FPC’s cap is reached.”
Richard Woolhouse, chief economist of British Bankers’ Association (BBA) said: “Overall this is a proportionate step by the FPC that focuses on personal indebtedness rather than house prices.”
It is widely believed that the lending cap will have little impact on the housing market in the short-term in terms of property prices, but sets an important backstop to prevent indebtedness spiralling, posing a risk to the broader economy moving forward.
In a statement George Osborne said: “I fully support this action by the Bank of England’s new Financial Policy Committee to use the new powers we have given them. It will help protect our hard-won economic security by better insuring us against any risks that might emerge in our housing market.”
The FPC also recommended that mortgage lenders apply an interest rate stress test to assess borrower affordability should interest rates rise three percentage points from the benchmark of 0.5%.
It is not in the BoE’s remit to control house prices or prevent a bubble, neither are they empowered to address the root of the issue which is undersupply of housing stock. BoE chief Mark Carney has instead chosen modest policies which provide a degree of risk management within the mortgage market that are unlikely to have an immediate effect in cooling down the market.
According to Carney many of the largest lenders already stress test borrowers’ capabilities to withstand a rise of 3% in interest rates and in the first quarter of 2014, just 11% of mortgage loans below the cap of 15% were at or equal to 4.5 times income.
The new policies were accompanied by policy projections issued by the BoE which modelled a central case of a 20% rise in house prices over the coming years. The BoE do not feel that this level would be a sufficient threat to engage the new policies.
However, it also models upside risks that would see house prices rise by 45%. In that scenario, the two policies would prevent 200,000 mortgages and lower house prices by 5%.
In essence, while the policies provide protection against the current recovery being thrown off course, they also clearly indicate that the future of the British housing market is totally unpredictable.
In the year leading to April 2014, British house prices increased by 9.9%, up from 8% in the year to March. London property led the price surge with a jump of 18.7%, according to data released by the Office for National Statistics (ONS) at the beginning of June.
The ONS also reported that nationally, house prices are about 4.4% above pre-financial crisis levels, strongly driven by London prices which are nearly 30% above those levels.
The BoE’s move last Thursday follows a warning to markets, businesses and householders at the beginning of June in Carney’s annual Mansion House speech that the Bank Rate, the principal economic tool of the BoE, one anchored by government on its ability to keep inflation on target at around 2%, could go up sooner than markets anticipate.
The objective behind the BoE’s mortgage tightening measures is to counter the nature of British economic booms and busts which can be longer because of the tendency to pay off mortgage debt before other payments.
Britons have a history of owning their own homes and recent surveys have shown that homeowners place mortgage debt above other priorities, doing everything they can to meet repayments even if it means cutting expenditure elsewhere. In so doing, householders delay spending which also delays economic recovery.
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