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Bank of England Warns of Risks and Urges Banks to Prepare for Funding Changes

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British Businesses and Households Coping with Higher Interest Rates, but Banks Must Prepare for Funding Changes, Says Bank of England

The Bank of England (BoE) has stated that British businesses and households have been managing higher interest rates reasonably well. However, the financial sector still faces risks and banks must be prepared for changes in the way they fund themselves. In its half-yearly Financial Stability Report, the BoE highlighted the uncertainty surrounding inflation and growth in advanced economies.

Governor Andrew Bailey acknowledged the challenging overall risk environment, stating, “Across advanced economies, the outlook for inflation and growth is uncertain.” The report also noted that stronger-than-expected wage and income growth since the last review in July has alleviated some financial strain for households. Nevertheless, households continue to face pressure from increased living costs and higher interest rates, some of which are yet to be reflected in mortgage repayments.

The report also indicated that businesses have been resilient thus far, despite higher rates and weak growth. However, the full impact of increased financing costs has not yet affected all borrowers. The BoE has raised interest rates at 14 consecutive meetings since December 2021, reaching a 15-year high of 5.25%, where they have remained. BoE officials have expressed concern about the long-lasting effects of last year’s surge in inflation but have no immediate plans to cut rates due to signs of ongoing inflation pressure.

Although the BoE does not currently plan to lower rates, British financial markets are increasingly predicting an early rate cut. This shift in expectations aligns with similar predictions for the European Central Bank and the U.S. Federal Reserve. The markets now anticipate a quarter-point rate cut by the BoE in May or June of next year.

The BoE has advised banks to proactively prepare for potential challenges in funding themselves. One concern is the shift in deposits from regular current accounts to fixed-term, higher-interest savings accounts, which increase costs for banks. The BoE affirmed that the UK banking system is well-capitalised and possesses high levels of liquidity. It also noted that net interest margins have likely peaked, but profitability is expected to remain strong. However, the recent run on U.S. lender Silicon Valley Bank has highlighted the vulnerability of lenders to sudden withdrawal surges, while the rise of digital currencies poses implications for deposit stability at banks.

The BoE outlined several risks to financial stability, including potential disruptions in China’s real estate market and tensions in the Middle East that could impact oil prices and economic growth. The report also raised concerns about outflows from corporate debt funds, increased positioning by hedge funds and asset managers in U.S. Treasuries, and their potential to fuel market volatility. Additionally, the BoE plans to monitor the risks associated with the rise of artificial intelligence in 2024.

Regarding corporate borrowers, the report identified higher risks for firms in wholesale trade, real estate, and construction sectors, as well as energy-intensive businesses. As for households with mortgages, over half of borrowers have been affected by higher borrowing costs. The share of income allocated to mortgage servicing is predicted to rise from 6.8% earlier this year to nearly 9% by late 2026. However, this would still be lower than after previous financial shocks.

Overall, the BoE’s Financial Stability Report provides an overview of the current economic landscape in the UK. While businesses and households are coping with higher interest rates, the financial sector faces risks that banks need to address. As uncertainties persist, the BoE urges banks to plan ahead for potential challenges in funding.

More detail via Reuters here… ( Image via Reuters )

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