BOE Warns Households Face Strain Similar to Pre-2008 Crisis

(Bloomberg) — The Bank of England has warned that some UK households may face a strain over debt repayments that is as great as before the 2008 financial crisis, if economic conditions continue to be difficult.

Most Read from Bloomberg

“It will be challenging for some households to manage the projected rises in the cost of essentials alongside higher interest rates,” the central bank’s Financial Policy Committee said in its quarterly Financial Policy Summary report released Wednesday.

Households overall are in a stronger position than they were before 2008. But if mortgage financing costs continue to rise, some may face pressure over their mortgage and other costs that are similar to the peak before the financial crisis, the BOE said.

Companies’ earnings will come under strain because of the higher cost of credit, according to the BOE. Higher costs and lower demand will weigh on the earnings for many businesses, especially those with large exposure to energy and fuel prices, the BOE said.

Foreign investors may also choose to steer clear of UK assets, which could feed through to falling prices and tighter credit conditions for households and businesses, the BOE warned. There may be a particular impact in areas such as commercial property where overseas investors have a big presence, it said.

Market Uncertainty

Ever since Chancellor of the Exchequer Kwasi Kwarteng announced a vast package of unfunded tax cuts last month that undercut the BOE’s inflation-fighting program, UK markets have been gripped by turmoil and the threat of collapse of a key part of the pensions industry.

The central bank was forced on Tuesday to expand its emergency measures to tackle chaos in the bond market, adding inflation-linked debt to its purchases in an effort to stop “fire sale dynamics.” The intervention followed a severe sell-off on Monday that saw UK inflation-linked yields surging by the most on record.

Story continues

The BOE said it would work with the pensions regulator and the Financial Conduct Authority to ensure that tougher standards are in place for pension schemes and LDI managers in the future.

“While it might not be reasonable to expect market participants to ensure against all extreme market outcomes, it is important that lessons are learned from this episode and appropriate levels of resilience are ensured,” the BOE said.

LDI Challenge

UK pension plans have offloaded all kinds of holdings in recent weeks to meet margin calls on derivatives they used to help ensure they have enough money to pay retirees decades in the future. Their sales were initially triggered by a proposed UK budget that would have brought the nation’s biggest tax cuts in five decades.

The central bank said it supported boosting the liquidity preparedness of market participants in the LDI sector, especially non-banks, for margin calls. Further sharp corrections in global asset prices could trigger further and faster redemptions from money market funds and open-ended funds that invest in less liquid and riskier credit assets, the BOE said.

Britain’s mortgage costs continued to climb this week after last month’s mini-budget roiled the market and caused some house sales to collapse. The average five-year fixed-rate mortgage on a home rose to 6.29% on Tuesday, the highest since November 2008 and up from 5.75% a week ago, according to Moneyfacts Group Plc. That’s as the two-year fixed-rate deal climbed to 6.43%, the most since August 2008.

House prices in the UK look set to slide next year as the cost of paying a mortgage is no longer cheaper than renting, according to UBS Group AG. Mortgage repayments as a proportion of income have increased to more than 40% after hikes to interest rates, analysts Gregor Kuglitsch and Marcus Cole wrote in a note Monday. That’s a “key pinch point” that will result in house prices dropping by 10% next year, they say.

(Adds context on LDIs and foreign investors.)

Most Read from Bloomberg Businessweek

©2022 Bloomberg L.P.