Why the Bank of England is Cautious about Endorsing a 6% Bank Rate: Assessing the Impact on Homeowners and the Mortgage Market

We doubt the BoE would endorse a 6% Bank Rate at this stage

But not pushing back against rate expectations is not the same thing as validating them. And we have strong doubts that the BoE will take rate hikes as far as markets expect.

Admittedly there’s no hard-and-fast rule that tells a central bank how high is too high. The BoE’s models have suggested that inflation will be well below target if rates were to go to the 5% area – let alone 6% – although policymakers have made it clear that they’re sceptical of these forecasts right now.

But if we look at the mortgage market – the main transmission mechanism for interest rates – then 6% rates would mean a homeowner with a 75% loan-to-value ratio would, on average, be paying close to 40% of their disposable income on repayments. That compares to roughly 30% at the peak going into the 2008 financial crisis.

The difference between now and then is that the share of households with a mortgage has fallen, and more people own their home outright now. And more importantly, around 90% of mortgages are fixed – predominantly for five years – a huge sea change compared to 10+ years ago when most were on variable rates. The result is that the length of time rates stay elevated is now arguably more important than the level, and the impact of 5%+ mortgage rates for a prolonged period would be large. The BoE is also right to highlight that the impact of past rate hikes is only now beginning to bite as a greater number of mortgage holders refinance.

 

Homeowners will be paying close to 40% of their average disposable income on repayments after refinancing

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