UK coping with higher rates for now but risks lie ahead – BoE

By Huw Jones and William Schomberg

LONDON (Reuters) – British businesses and households are coping with higher interest rates so far, but the financial sector still faces risks and banks must get ready for changes to the way they fund themselves, the Bank of England said.

“The overall risk environment remains challenging. Across advanced economies, the outlook for inflation and growth is uncertain,” Governor Andrew Bailey said.

In its half-yearly Financial Stability Report, the BoE said stronger-than-expected wage and income growth since its last review in July had reduced some of the strain for households.

“Nevertheless, household finances remain stretched by increased living costs and higher interest rates, some of which has yet to be reflected in higher mortgage repayments,” the BoE’s Financial Policy Committee said.

Businesses had also been broadly resilient to higher rates and weak growth, “but the full impact of higher financing costs has not yet passed through to all borrowers,” it said.

The British central bank, worried about the long-lasting impact of last year’s surge in inflation, raised interest rates at 14 meetings in a row between December 2021 and August this year to a 15-year high of 5.25%, where they have sat since.

BoE officials acknowledge signs of a slowdown in the economy but say they are not thinking about cutting rates because of signs that inflation pressure will stay strong.

“Rates likely to need to remain at these levels for an extended period to bring inflation back to target on a sustained basis,” Bailey said at a press conference on Wednesday.

However, British financial markets have stepped up bets on an early rate cut by the BoE in the past couple of days, following a similar shift in expectations for the European Central Bank and U.S. Federal Reserve, and now see a first quarter-point cut in May or June next year.

HIGHER FINANCING COSTS

The BoE urged banks to plan ahead for potential challenges in the way that they fund themselves, given a switch in deposits from normal current accounts to fixed-term, higher-interest savings which cost them more.

“The UK banking system is well capitalised and has high levels of liquidity,” the BoE said, adding that net interest margins have probably peaked but profitability was expected to remain robust.

However, the run on U.S. lender Silicon Valley Bank this year highlighted how lenders could be hit with sudden surges in withdrawals and the prospect of digital currencies also had implications for the stability of deposits at lenders.

Risks flagged by the BoE included upheaval in China’s real estate market which could worsen, and tensions in the Middle East which could push up oil prices and hurt economic growth.

Outflows from funds invested in risky corporate debt and increased short and long positioning by hedge funds and asset managers in U.S. Treasuries could fuel further market volatility, the BoE said.

The central bank said it would monitor in 2024 the risks posed by the rise of artificial intelligence.

The BoE said that among corporate borrowers, firms in wholesale trade, real estate and construction and those which were energy-intensive faced higher risks than their peers.

As for households with mortgages, higher borrowing costs had impacted just over half of borrowers and the share of income spent on mortgage servicing was due to climb from 6.8% earlier this year to almost 9% by late 2026, although that would be lower than after past financial shocks.

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