Personal Investing
Ed Monk Fidelity Personal Investing 6 Jul 2017 03:38pm

UK economy passes its MOT with a few repairs

SPONSORED FEATURE: If the UK economy was a car, the Bank of England’s Financial Stability Report would be its MOT
Caption: If the UK economy was a car, the Bank of England’s Financial Stability Report would be its MOT.

Conducted not annually but twice a year, the latest report pointed out a number of warning lights now flashing on the dashboard, and prescribed various maintenance jobs it thinks are necessary to keep the economy roadworthy.

Many of the dangers now facing the UK revolve around household debt - mortgages but also the plethora of other credit products we use including credit cards, loans and car finance.

These are never too far from the thoughts of regulators at the Bank because high levels of debt tend to make any periods of economic difficulty that much worse. Households in deep debt become even more cautious when the going gets tough and cut their spending more drastically than otherwise they would. At the same time, the banks that made all those extra loans are hit harder when defaults start to rise.

There has, of course, been much attention on debt ever since the financial crisis and the Bank of England, in 2014, insisted upon a range of potential limitations on mortgage lending to prevent bubbles emerging.

Even with these limits in place, the Bank said that mortgage lending at high loan-to-income ratios had increased in the past year, while lenders were making loans at tighter and tighter margins. Mortgage debt was now worth 101% of household income, the Bank said.

As such, the report recommended the 2014 mortgage limits remain in place.

More urgent attention may be needed in the area of non-mortgage consumer debt. Consumer credit grew by 10.3% in year to April, markedly faster than growth in household incomes. Credit card debt, personal loans and motor finance all grew rapidly.

Added to this, the Bank found that lenders in these areas have been weakening their underwriting and holding less capital in reserve following a period of low rates and relatively benign conditions for borrowers. In other words, we may all be getting a bit too used to low-cost credit.

As such, the Bank will bring forward tests to establish how lenders would cope with significant extra stress in these markets. More generally, the bank will gradually ratchet up the cash buffers that banks are required to hold to improve protection should a new downturn strike.

Other risks to the UK highlighted by the Bank today included the over-indebtedness of China (debt again) and some potentially overpriced asset classes. The Bank picked on corporate bonds and UK commercial real estate in particular, as being exposed.

It said that valuations in these assets were based on interest rates remaining low in the long term, but that they did not also reflect the deteriorating economic outlook that is also entailed in such an interest rate environment.

“These asset prices are therefore vulnerable to a repricing, whether through an increase in long-term interest rates or an adjustment of growth expectations, or both”, the Bank said. “The impact of this could be amplified given reduced liquidity in some markets.”

Finally, the Bank reserved much of its focus for Brexit, and the risks that various scenarios pose for the UK economy.

There is, of course, very little certainty about what those scenarios will be. To return to our motoring analogy, the Bank is attempting to diagnose repairs before the journey has begun, and with the length of the journey, and the terrain to be covered, still unknown.

However, in line with its remit to prepare for economic shocks, the Bank laid out the implications of the UK leaving at the end of the negotiation period without any deal in place.

In no particular order, these include: massive disruption to, and higher costs of, banking, insurance and capital market services in the UK; an abrupt increase in the cost of cross-border trade; a reduction of economic activity in high tax-paying sectors with a subsequent hit to public finances; a material reduction in the appetite of foreign investors to provide finance to the UK, which would tighten financing conditions for UK borrowers and reduce asset prices and investment; and a depression of the exchange rate and upward pressure on inflation.

To repeat, this is the pessimistic view. One can only wonder what the repair job would look like if the economy suffered that kind of impact.

Ed Monk

Ed Monk

Ed joined Fidelity in 2016 following a 13-year career in newspaper journalism, most recently as investment editor at The Daily Telegraph. He was previously news editor and personal finance editor for, the money channel for Mail Online and has contributed articles to the Daily Mail.

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