That’s something we’ve been hearing a lot about lately.
Deutsche Bank analysts had the thought but didn’t finish the sentence in a note on the Financial Services Authority’s Financial Risk Outlook and UK banks published last week:
The FSA document expresses concern around the continued increase in household leverage driven by growth in mortgage borrowing more than offsetting the limited reduction in unsecured lending. It also confirms our concerns around the UK’s increasing gearing to floating interest rates and potential under-reserving for fragile borrowers given how cheaply existing mortgages can be serviced while interest rates are this low. Households are currently benefiting from ~£100bn p.a. reduction in mortgage servicing costs (so why is deposit growth so low?), but with the economy becoming increasingly geared to low interest rates as the proportion of floating rate debt continues to dramatically increase (Figure 15 shows increase to 60% of mortgages at 3Q09, we expect c.63% by end 2009).
“… but with the economy becoming increasingly geared to low interest rates …”
… the low-interest rate benefit could quickly disappear?
That’s our guess. But Moody’s is much more explicit.
In a report published on Monday the rating agency discusses interest rate shock for a select few European economies — the UK, Spain and Holland to be specific. The thrust of the report:
The prevalence of floating-rate mortgage borrowers in Spain and the UK means that more borrowers in these countries will be affected by interest rate rises than in the Netherlands. The resulting impact of the interest rate shock felt by the affected borrowers will partly depend on the level of non-amortising mortgages, which are more common in the Netherlands and the UK compared with Spain. The UK features the most prominently in our Interest Rate Shock Map due to the combined impact of the potential number of borrowers affected and the associated size of such a rate shock.
In other words based on the structure of the mortgage market — that would be the prevalence of floating mortgages — and qualitative factors like the proportion of household debt, the UK is most susceptible to an interest rate shock of the three economies featured in the report.
And here’s the shock map:
The area of the bubbles is meant to represent the level of household debt to disposable income. The size of the shock on the y-axis is defined as the percentage increase in monthly payments using a ‘stressed’ (i.e. higher) interest rate. So the upper left-hand corner is to be avoided ideally.
Anyway, here’s what the FSA’s Risk Outlook had to say about it last week:
It is possible that this trend will continue for some time. However, any future significant rise in unemployment, widespread loss of income or material increase in interest rates could affect a wider group of homeowners. As the economy begins to recover, interest rates may return to more normal levels, increasing the cost of debt before household incomes have recovered fully. Such income or debt-cost shocks could yet trigger a more disorderly deleveraging process through higher arrears and repossessions.
(H/T Gary Jenkins at Evolution for the Moody’s tip-off)
Related links:
Shadow bank losses – FT Alphaville
Rally fuelled by cheap money brings a sense of foreboding – FT