This may not be the main thing that financial markets are looking at right now, but the Bank of England has announced it is thinking of removing another hurdle from the path or house price inflation.
House prices in the UK keep breaking record after record, with the average price of a home reaching £260,000 for the first time in February – an increase of 12.6% from the same month a year ago, according to data from building society Nationwide.
And yet, this breakneck pace of growth does not seem to be enough for the Bank of England. Instead of thinking of ways to slow it down, the central bank seems determined to fan the flames of house price inflation.
A recent consultation it has put out suggests that the central bank is thinking of removing a crucial affordability test for house buyers, which required lenders to make sure that borrowers could afford to pay back loans if interest rates were to increase by three percentage points.
More precisely, the requirement was phrased as follows:
“When assessing affordability, mortgage lenders should apply an interest rate stress test that assesses whether borrowers could still afford their mortgages if, at any point over the first five years of the loan, their mortgage rate were to be 3 percentage points higher than the reversion rate specified in the mortgage contract at the time of origination (or, if the mortgage contract does not specify a reversion rate, 3 percentage points higher than the product rate at origination).”
In its own words, the Bank of England proposes removing the 3.0% interest rate increase requirement to make guarding against the risks of higher household debt ” in a simpler, more predictable, and more proportionate way.”
The Bank of England does not cancel all its prudential regulation. It will maintain the requirement that the number of mortgages that are at or above 4.5 times the borrower’s income should be limited to 15% of the lender’s new mortgage lending.
By its own estimates, around 6% of borrowers (30,000 per year) have taken out smaller mortgages than they would have been able to in the absence of the interest rate affordability requirement.
So it is fair to assume that this number of people will likely get access to higher mortgages, once the interest rate affordability requirement is removed.
Is it wise to increase the number of people getting access to mortgages just as interest rates are set to rise because inflation is going through the roof? Why is the central bank talking about such a measure at this time?
In the arguments listed on its website for the recommendation, the central bank states that the Financial Policy Committee’s second objective (after financial stability) is to support the government’s economic policy, including its objectives for growth and employment.
The explanation could then be that as other sources of economic growth, such as exports, get chocked by Brexit-induced bureaucracy, the bank is trying to manufacture domestic growth by encouraging people to keep buying homes.
But the household debt-to-income ratio is 125% already, according to the Bank of England’s own figures. In a scenario of rapid house price growth and without the central bank’s mitigating measures, it could even reach 200%.
If the economy crashes, in a depressingly familiar scenario the taxpayer will once again be called upon to correct the effects of this excess.
The question is whether there will be enough left in the taxpayer’s pocket to save the banking system again. The answer to this question may not be the one that policymakers hope for.