The UK is bracing itself for the impact of higher interest rates, as the country faces a potential “double whammy” that could have significant consequences for consumer spending and corporate debt. This warning comes from the Bank of England, which states that the full effects of elevated borrowing costs have yet to be realized. As a result, two-thirds of UK adults have already reduced their discretionary purchases, and retail sales are nearly stagnant in terms of volume. Furthermore, there has been a noticeable increase in credit card debt, growing at double-digit rates annually.
The UK’s weak level of investment exacerbates the reliance on consumer spending, according to John Van Reenen, a professor at the London School of Economics. He believes that this situation creates a “doubly whammy” due to the sharper rise in UK interest rates and the country’s heavier reliance on consumption. The implications for growth prospects are apparent, with the UK expected to remain stagnant. The International Monetary Fund (IMF) has revised its forecast for next year from 1% to 0.6%, while Bloomberg’s consensus estimate is even lower at 0.4%.
The potential consequences of these developments are also being felt in the corporate debt market. Distressed prices for UK corporate debt have increased by nearly 50% since late last month, surpassing $15 billion, according to Bloomberg News. The Bank of England has warned that one in two companies is likely to struggle with servicing their debt by the end of the year. This could lead to a significant reduction in investment and employment.
The influence of consumer spending on the debt markets is also evident. Approximately 35% of high yield bonds and leveraged loans issued by UK firms are in the consumer discretionary sectors, compared to 26% in the rest of Western Europe, as reported by Bloomberg. This heightened exposure makes the industry more vulnerable to a recession.
The attractiveness of UK corporate debt is further diminished by the vulnerability caused by consumer spending and the Bank of England’s quantitative tightening program. The program involves the selling off of bonds that were purchased during a prolonged period of low interest rates. As a result, spreads are narrowing, making sterling-denominated company bonds less appealing.
The weakening consumer can be partly attributed to the increase in mortgage payments for homeowners and landlords who are refinancing off historically low rates. This trend is already affecting the market for buy-to-let mortgage debt, which has seen a 60% increase in arrears compared to the previous year, according to Cristina Pagani, a director at Fitch Ratings. Additionally, non-conforming mortgages, which are loans to homeowners who don’t meet traditional mortgage criteria, may also experience an uptick in arrears due to higher interest rates.
The commercial real estate market could also face challenges if the pound weakens and swap rates rise, warns Sue Munden, a senior real estate analyst at Bloomberg Intelligence. Listed Real Estate Investment Trusts (REITs) may face higher borrowing rates, and private sector landlords, who have taken on higher leverage, may be compelled to sell assets to repay loans as property prices fall.
This “double whammy” of higher interest rates and a reliance on consumer spending presents a challenging situation for the UK. With the potential for reduced growth, struggling companies, and vulnerabilities in the debt market, it is imperative for policymakers and businesses to navigate these challenges carefully to mitigate any adverse effects on the economy.
More detail via The Straits Times here… ( Image via The Straits Times )