Bank of England says UK economy is coping with high interest rates

Britain’s economy is so far proving resilient to a surge in interest rates over the past year and a half, but it will take time for the full impact to feed through, the Bank of England (BoE) said on Wednesday.

The Bank of England last month raised rates to 5 per cent that had stood at 0.1 per cent at the end of 2021, raising concerns about a hit to households, businesses and the broader financial sector that could push the economy into a recession.

But in a half-yearly assessment of the health of the financial system, the BoE said there was no reason for alarm.

“The UK economy and financial system has so far been resilient to interest rate risk,” BoE Governor Andrew Bailey told a press conference.

“We will continue to monitor credit conditions for any signs of tightening which are not explained satisfactorily by changes in the macroeconomic outlook.”

The proportion of highly indebted households was rising, but even considering the higher cost of living - with inflation at 8.9% in May - it was likely to remain below the peak seen in 2007.

On Tuesday, average interest rates for new two-year fixed-rate mortgages - the most common form of housing finance - rose above their peak following last September’s mini-budget to a 15-year high of 6.66 per cent, according to data provider Moneyfacts.

Britain’s finance industry estimates 800,000 households will need to refinance onto more expensive mortgages in the second half of 2023, and a further 1.6 million in 2024.

The Bank said the typical mortgage holder refinancing later this year would pay an extra 220 pounds ($285) a month and that, by the end of 2026, nearly 1 million households would be paying at least 500 pounds a month more.

It said British banks were less exposed than households to the adverse effects of higher interest rates, especially compared with financial institutions in other countries, while the corporate sector remained “broadly resilient”.

“Nevertheless, higher financing costs are likely to put pressure on some smaller or highly leveraged firms,” it added.

The BoE saw particular risks in global commercial real estate and from corporate borrowing in the private credit and leveraged lending markets.

Britain’s eight largest lenders all have enough capital to cope with higher rates, the BoE announced following its annual ‘stress test’ of the sector:

“Major UK banks’ capital and liquidity positions remain robust and profitability has increased, which enables them both to improve their capital positions and to support their customers.”

The BoE’s Financial Policy Committee left banks’ counter-cyclical capital buffer, a tool used to manage risk and lending over the credit cycle, unchanged at 2 per cent.

The Bank added that, following the collapse of Silicon Valley Bank, it was working with the finance ministry to ensure that there were options to smoothly wind up small banks that were exempt from some requirements applying to larger ones.

Meanwhile Britain’s eight largest lenders have enough capital to ride out a worse economic crisis than that seen in 2008, the Bank of England (BoE) said on Wednesday, as the sector faces sharply rising interest rates pummelling consumers and businesses.

The test checked if banks had enough capital to weather theoretical shocks under a scenario which the BoE said was more severe than the global financial turmoil of 2008 when British taxpayers had to bail out several lenders. The test also measured how well the lenders would cope with a global rise in interest rates. The eight banks account for 75 per cent of lending in Britain.

“The UK economy and financial system have so far been resilient to interest rate risk,” BoE Governor Andrew Bailey said, though he noted the full impact of higher interest rates had yet to be felt.

The stress tests incorporated persistently higher inflation in advanced economies, rising global interest rates, deep recessions and higher unemployment, as well as sharp falls in asset prices. “Major UK banks’ capital and liquidity positions remain robust and profitability has increased, which enables them both to improve their capital positions and to support their customers,” the BoE said.