It’s been a rough week for anyone worried about the cost of financing debt. And, to be frank, everyone probably should be worried about the cost of financing debt from governments, to big corporates, renters and homeowners alike.
Let’s recap the facts. Earlier this week the domestic money markets were pricing in Bank of England interest rates to hit 5.75% – a jump in prediction of the peak interest rate of over 0.75% in just a month. This is almost certainly in part to the persistently tight UK labour market and stubborn inflation. Combine that with UK gilt yields sailing past previous recent highs, with the yield on a 2-year gilt (an instrument critical to pricing mortgages) sitting today at 4.85%. The Government spent £106.7bn financing its debt in the year ending March 2023, expect that number to soar this coming year.
Painfully high interest rates and gilt yields will have serious implications for anyone looking to refinance or take out a mortgage in the coming months, and potentially years. About 1.4 million households will be renewing their mortgage this year, and the vast majority can expect to pay considerably more than they were before.
Given the volatility of interest rates, it’s little surprise that banks are resetting mortgage rates on an almost weekly basis. HSBC pulled their entire suite of mortgage products twice this week before reintroducing them with higher rates. Their 2-year fixed now sits at 5.29% and their variable rate is a staggering 6.99%. At a time when we have more mortgage debt than ever before, interest rate rises of 3-4 percentage points will have life-changing consequences for many families.
Spare a thought for 4.4 million private renter households too. Many live in homes owned by buy-to-let investor landlords. Renters have already been squeezed, with private rental prices in London increasing by 4.8% on average in the 12 months to March 2023. Renters already spend almost a quarter of their median weekly expenditure on rent, according to the ONS.
Slap on top of that inflationary pressures on bills, and it’s been pretty tough for renters of late. This is before landlords pass on increased costs of their mortgages to renters, further driving up the cost of rent at a time when it is already difficult to get a deposit together. The dream of home ownership is slipping further out of view for many people.
These are the real-world consequences of eye-watering interest rates. According to USwitch, 750,000 homeowners will live in a form of financial poverty by the end of 2023, if interest rates don’t stabilise or reduce. A great many are simply not going to be able to make ends meet, forcing us to address the uncomfortable subject that people are going to have to reckon with, a mass defaulting of loans.
Termites in the housing market
For as long as I can remember, the line on the graph for house prices in the UK has continuously crept up, save 2008, the last credit crisis. This has been a great investment for homeowners, offering a secured return which has allowed many to enjoy comfortable retirements or buy dream homes on the back of their property value.
The increased value of property means that eyewatering sums of money can, and have, been secured on dwellings in the UK. Between 2020 and 2023, there has been a 3.5% year-on-year increase in the amount of money secured on dwellings, standing as of February 2023 at £1.63tn.
This stack of money secured on UK property since 2008 has been built in an environment of rising property value, and importantly, cheap money. For much of the last decade, UK interest rates have sat below 1%, only breaching that figure last year. This allowed households to borrow increasing sums of money against property relatively inexpensively. All of that is about to change.
The threat of increased mortgage costs to the debt pile secured against UK dwellings is, in my view, twofold. First is the obvious issue of defaulting on loans. A large stack of money, built on the back of low-interest rates, needs to be paid back. Increased costs in financing this debt in turn increases the real risk of default.
The second is the return of our old friend negative equity. As some people in the market default, and/or sell their ‘distressed asset’ for a knock-down price, there is the real risk of a reckoning when it comes to house prices – especially when you couple this with the more straightforward problem that the increased cost in borrowing shrinks demand.
Mix all this together and we have a serious debt crisis in the housing market on our hands once again. This is before touching on the level of unsecured household debt in the UK, which is estimated to be north of £400bn. Whisper it, but this could end up as a seismic credit crisis.
What are we going to do about it?
Overcoming this looming crisis and preventing it from being an ‘08 style credit crash is going to need decisive government action.
One such plan being talked up in hushed whispers is reintroducing tax breaks for mortgages. One way to do this would be to make interest paid on mortgages tax deductible. This has the potential to ease the burden on households but will do little to alleviate market fears about the size of the UK debt pile.
We already know what effect unfunded tax cuts have on the UK gilt market. While unfunded cuts to income tax are not the same as making mortgage payments partly tax deductible, the policy could well increase borrowing for the government and either push gilt yields up further, or at least keep them at worrying levels. This could be the Government’s best and only option.
Another proposal that has been mentioned more than once in passing involves the devaluation of the pound. Thankfully I am yet to see this seriously entertained, the mere threat could send the hares running.
What the UK does need is stability from both the Government and the Bank of England. The Bank should not kill off one crisis (inflation) by inducing a far more menacing one, and therefore we can only hope they won’t increase interest rates any further, following in the footsteps of the Fed.
Rishi Sunak, the Tories, and the Bank of England have one shot at getting this right and prevent seeing hundreds of thousands slide into poverty, the drying up of critical lines of credit to corporate Britain, and the potential collapse of the mortgage markets. Get it wrong and expect to not be allowed to govern the UK for a very long time.
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