The Bank of England’s (BoE) Financial Stability Report found that in the first quarter of 2022, the share of mortgaged households with a high cost of living ratio was 1.7 per cent, up from 1.4 per cent in 2020. It said this was “around the historical average” and significantly below the peak of 2.8 per cent seen before the global financial crisis.
The BoE said stretched mortgaged households were “not projected to rise substantially”.
The central bank said this was in part because of the Financial Policy Committee’s (FPC) recommendations to the mortgage market, which “guarded against a material loosening in underwriting standards and an excessive build-up of household debt”.
The impact of higher interest rates is also expected to be less severe than in the past due to a rising share of fixed rate mortgages.
As of 2022 Q1, 80 per cent of the outstanding value of residential mortgages was at a fixed rate, compared with 55 per cent five years ago.
It said the share of households with a high cost of living were “nevertheless expected to increase in 2023” but would remain below previous highs.
The report added: “Market expectations are for interest rates to continue to rise and more of the increases will be passed through to households with mortgages as they come to the end of fixed-rate periods. Unemployment is also projected to increase.”
It was noted that market expectations for the bank rate had been revised upwards. The bank rate is now predicted to reach 2.8 per cent by the end of the year and peak at 3.3 per cent in 2023.
Despite households being protected from rate rises, BoE said further deterioration in the macroeconomic outlook would weigh on GDP and lead to higher unemployment. It also said if wage increases were more limited for lower income or stretched borrowers, they would face “greater financial pressures than projected”.
The bank said this could lead to a tightening in lenders’ risk appetite and worsen the impact on households’ debt affordability. It also predicted that some people would borrow more to raise capital, which would in turn increase their debt burdens.
Lower income households more vulnerable
BoE found that lower income households spent around 90 per cent of their income on essential expenses, while higher income households spent around 45 per cent.
As a result, lower-income households will find it harder to adjust spending behaviour in response to rising prices. It was noted that inflation was now expected to reach slightly over 11 per cent by the end of the year, potentially impacting on household income.
The report said these low-income households also saved at a lower rate while higher income households tended to have housing equity, which could serve as collateral.
However, it noted that lower income households also held a smaller share of outstanding mortgage debt.
Banks resilient against economic downturn
The FPC determined that “major UK banks have capacity to weather the impact of severe economic outcomes”.
It said the profitability of major banks and building societies remained strong in Q1 2022, as did their capital and liquidity positions. This was evident by pre-provision bank operating profits rising by 37 per cent annually.
It said banks were still in a position to lend to households and businesses. The report said if banks were to adjust lending behaviour to reflect the new risk environment, this would be appropriate.
However, it warned that restricting lending purely to protect capital ratios or buffers would be “unproductive” and prevent credit-worthy borrowers from accessing funding. It noted that such “excessive tightening” would harm the economy and banks themselves.
Climate change risk
The report also referred to the BoE’s Climate Biennial Exploratory Scenario (CBES), which was published in May. This examined the potential impact of climate change in three scenarios: early action, late action and no action.
It found that UK banks and insurers were “making good progress” in some areas but identified varying quality in different approaches.
It said firms had more work to do to improve climate risk management and understand modelling limitations where third parties are used.
Climate risks are expected to have a negative impact on the profitability of banks and insurers, with profit declines of 10 to 15 per cent on average.
In the no action scenario, the BoE said there would be restrictions in access to credit and insurance for sectors and households most vulnerable to physical risks. It said insurers would increase premiums making coverage unaffordable, and in the worst-affected properties insurance availability could be removed completely. Access to finance could also be reduced for at-risk homes.