Lenders need to be alive to market changes to support borrowers

Dean Carter, Recognise Bank’s Group Treasurer, discusses the role lenders can play to keep the market flowing during the current economic challenges.

If the Bank of England’s decision to raise the Base Rate to three per cent wasn’t much of a surprise, then the notes about the Monetary Policy Committee’s (MPC’s) decision are likely to raise a few eyebrows.

Among the rationale for the 75 basis points hike was a line that said: ‘No assumptions made about planned 17 November fiscal statement’.

This statement being Chancellor Jeremy Hunt’s Autumn Budget and his response to Kwasi Kwarteng’s mini Budget which has reportedly left a £50bn black hole in the nation’s finances.

I was struck by how the government was seemingly so blind to the other side of the economic equation

Dean Carter

To my mind, such an admission shows just how out of kilter the Bank and the government are. As I digested Kwarteng’s announcement in September, I was struck by how the government was seemingly so blind to the other side of the economic equation.

The Budget, set by the government, is all about fiscal policy, but the Bank of England is all about monetary policy, and in September those two bodies seemed at odds with each other.

The damage has been done
The Bank of England is raising interest rates to try and reduce inflation. This not only suppresses growth, but also reduces most working incomes by increasing their borrowing costs. And that’s on top of the 10 per cent inflation on real earnings, which is where the cost-of-living crisis is really being felt.

The Truss government’s plan for cutting taxes would have done little to help those being hit hardest by inflation, and because the proposed tax cuts were unfunded, the markets responded badly. While Hunt has reversed those tax plans to calm the markets, with tax rises now being heavily hinted at, the damage has been done.

Analyst Capital Economics puts the average house price at £270,000 with an 80 per cent loan to value (LTV) mortgage of around £216,000. If mortgage rates rise from 2.5 per cent to around 5.5 per cent, then the mortgage cost will increase from around £970 to £1,320 a month for a 25-year repayment mortgage, or an extra £4,200 a year.

If the borrower’s household currently spends 35 per cent of its disposable income on that mortgage, a higher rate pushes that to around 50 per cent of disposable income, leaving the remaining 50 per cent for everything else, including energy, water, food and other debts, before you get to luxuries like Netflix, holidays and Christmas.

Keeping abreast of market changes
The markets have been predicting a peak bank rate of 5.25 per cent next year, although the Bank seems to be downplaying this by forecasting inflation would be below target in Q4 2025 if the bank rate is left at three per cent.

This doesn’t mean that the current three per cent is the peak but suggests the MPC have little appetite for a rate that high.

A bank rate around five per cent would cause even more pain to pretty much the entire working population. Those that couldn’t afford their higher mortgage costs might default, first-time buyers wouldn’t be able to get on the ladder due to higher rates and a bigger burden on their household income, while others would be less likely to move on up the property ladder.

The Bank set out a gloomy economic picture for the next couple of years but did so without being able to reference the government’s fiscal policy – because there really isn’t one. And as we have seen over the last of years, from Covid to Ukraine to Kwarteng’s Budget, things can change quickly, impacting the global economy – for good or for bad.

As lenders, we need to be alive to this ever-changing picture so we can respond and continue to support our customers.

This article was originally published in Mortgage Solutions on 14th November 2022.