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Bank of England: EU referendum is risk to economic stability Bank of England warns that vote to leave EU risks a credit crunch
(about 3 hours later)
The Bank of England has warned that the referendum on Britain’s membership of the EU is the biggest immediate domestic threat to financial stability and that market fears about the outcome could push up borrowing costs for households and businesses. The Bank of England has given David Cameron a significant boost ahead of the EU referendum by warning that a vote to leave risks causing a run on sterling, a credit crunch and higher interest rates for mortgage payers and businesses.
The Bank’s financial policy committee, whose job is to monitor risks to the financial system, added the EU referendum, set for 23 June, to its list of risks to stability. It said uncertainty around the vote could increase the price investors demand to invest in UK assets, force down sterling and increase the cost and availability of financing for UK borrowers. Threadneedle Street said the closely fought campaign posed the “most significant near term” domestic risk to financial stability, after one of its key policy committees weighed up the consequences of Britain ending its 43-year relationship with the EU.
The UK’s near-record current account deficit, the gap between what Britain buys and sells plus losses on overseas ventures, relies on foreign direct investment that could be damaged by continued uncertainty, the committee said. That funding, which helps finance Britain’s public sector deficit and corporate investment, could be affected by the referendum, the Bank warned. Although neither Downing Street nor the Treasury responded to the statement from the Bank’s financial policy committee (FPC), the prime minister and the chancellor, George Osborne, will find its assessment useful as they attempt to make the case for a remain vote on 23 June.
The Bank has deliberately made no comment about the long-term costs and benefits of Britain remaining in the EU, but is making contingency plans for the turbulence that it expects – in the UK and the eurozone – in the event that the Brexit camp prevails.
The FPC statement warned that “heightened and prolonged uncertainty” had the potential to drive up interest rates for a wide range of assets, “which could lead to a further depreciation of sterling and affect the cost and availability of financing for a broad range of UK borrowers”.
It said the pressures had the potential to heighten existing vulnerabilities for financial stability, stressing the fact that Britain relied on foreign investors to fund a balance of payments deficit on current account that was “high by historical and international standards”.
That shortfall, the FPC said, could only be financed through continuing hefty inflows of direct investment and speculative cash, and there would be an impact for the cost of government borrowing and the property market if they dried up.
“Those flows have contributed to the financing of the public sector financial deficit and corporate investment, including in commercial real estate,” the FPC said.
A decision by the UK to withdraw from the EU could “spill over to the euro area, driving up risk premia and further diminishing the prospects for growth there,” it added.
Mark Carney, the Bank’s governor, told MPs this month that the referendum was the main homegrown threat to stability, but the FPChas formalised the threat and given it the backing of the full committee. It also sets out in stark terms the potential impact on the government and households if markets take fright at a possible vote to leave.
The campaign to stay in the EU seized on the FPC’s warning, emphasising the fact that it is made up of experts independent of Carney, who chairs the committee. His warning to MPs caused a political row as leave supporters accused him of compromising the Bank’s independence.
The former chancellor Alistair Darling said: “This assessment makes it clear our economy would be more vulnerable and less resilient if we vote to leave the EU – leading to higher mortgage rates for families and higher interest rates for Britain’s businesses. It is a serious piece of work that should make everyone think twice about irresponsibly gambling with people’s jobs and livelihoods.”
Matthew Elliott, the chief executive of Vote Leave, said: “The biggest risk to the UK economy, a risk that even the Bank of England acknowledges, is Britain remaining in a declining political union where we are outvoted and our trade is held back. Even pro-EU campaigners have admitted that after we vote leave on 23 June, we will secure a deal where the economy will grow and jobs will be created. The safest thing for our economic security is to spend our money on our priorities.”
Related: Whether it likes it or not, Bank of England is in the thick of Brexit debateRelated: Whether it likes it or not, Bank of England is in the thick of Brexit debate
“The committee assesses the risks around the referendum to be the most significant near-term domestic risks to financial stability,” the FPC said. “The FPC judges that the outlook for financial stability in the United Kingdom has deteriorated since it last met in November 2015. Domestic risks have been supplemented by risks around the EU referendum.” The FPC said: “The FPC judges that the outlook for financial stability in the UK has deteriorated since it last met in November 2015. Domestic risks have been supplemented by risks around the EU referendum.”
The FPC said the referendum could reinforce existing weaknesses in the system and increase concerns in funding markets already unnerved by global volatility this year. A decision to leave the EU could damage the eurozone’s economy with a spillover to UK trade and the economy, the committee added.
The committee set out a range of risks that had increased, including weak emerging market economies, especially China, low profitability for banks and falling asset prices. It warned of a potential threat to financial stability from lax buy-to-let mortgage lending as the Bank’s regulatory arm set extra tests for loans to landlords.
Mark Carney, the Bank’s governor, told MPs this month the referendum was the main home-grown threat to stability but the FPC’s warning formalises the threat and gives it the backing of the full committee. It also sets out in stark terms the potential impact on the government and households if markets take fright at a possible vote to leave.
The campaign to stay in the EU seized on the FPC’s warning, stressing its makeup of experts independent of Carney, who chairs the committee. Carney’s warning to MPs caused a political row as supporters of leaving the EU accused him of compromising the bank’s independence.
Alistair Darling, chancellor in the final years of the last Labour government, said: “This assessment makes it clear our economy would be more vulnerable and less resilient if we vote to leave the EU – leading to higher mortgage rates for families and higher interest rates for Britain’s businesses. It is a serious piece of work that should make everyone think twice about irresponsibly gambling with people’s jobs and livelihoods.”
Related: Bank of England must burst the buy-to-let bubble nowRelated: Bank of England must burst the buy-to-let bubble now
The FPC said the EU vote was an added threat to financial stability on top of risks that were on the rise. Household debt is relatively high and the risks from credit growth have risen beyond their subdued levels following the financial crisis though they are not yet “elevated”, the committee said. The EU vote was an added threat to financial stability on top of risks that were on the rise, it added. Household debt is relatively high and the risks from credit growth have risen beyond their subdued levels following the financial crisis, though they are not yet “elevated”, the committee said.
The Bank is taking action to rein in buy-to-let mortgage lending, which it has been watching with concern for some time. Last year, the stock of buy-to-let mortgages increased by 11.5% while the stock of lending to owner occupiers remained unchanged. The Bank is taking action to rein in buy-to-let mortgage lending, which it has been watching with concern for some time. Last year, the stock of buy-to-let mortgages increased by 11.5%, while the stock of lending to owner occupiers remained unchanged.
The market has leapt back into life over the past three years after slumping during the financial crisis. Last year, gross lending for buy-to-let property jumped to about £37bn, up from less than £10bn in 2009 and approaching the peak of almost £45bn in 2007.The market has leapt back into life over the past three years after slumping during the financial crisis. Last year, gross lending for buy-to-let property jumped to about £37bn, up from less than £10bn in 2009 and approaching the peak of almost £45bn in 2007.
Lenders plan to increase buy-to-let lending by an average of 20% a year over the next two years, the Bank’s regulatory arm, the Prudential Regulation Authority, found. About a quarter of lenders are applying weaker lending standards than the market norm, raising fears they will suffer large losses if the market changes. Lenders plan to increase buy-to-let lending by an average of 20% a year over the next two years, the Bank’s regulatory arm, the Prudential Regulation Authority, found. About a quarter of lenders were applying weaker lending standards than the market norm, raising fears that they will suffer large losses if the market changes.
The FPC said it “remains alert to potential threats to financial stability from rapid growth in buy-to-let mortgage lending”. The PRA, the Bank’s regulation arm, is concerned that changes to mortgage interest tax relief for landlords will strain buy-to-let borrowers and that only a few lenders include this risk when assessing mortgage applications.
The Bank has been monitoring the market’s resurgence closely for its potential to cause a new property crash with reverberations for banks and the wider economy. It set out measures that it predicted would reduce the number of new buy-to-let mortgages by between 10% and 20% during 2018:
The Prudential Regulatory Authority, the Bank’s regulation arm, is concerned that changes to mortgage interest tax relief for landlords will strain buy-to-let borrowers and that only a few lenders include this risk when assessing mortgage applications.
The PRA set out measures it predicted would reduce the number of new buy-to-let mortgages by 10-20% during 2018:
The PRA will start talking to lenders immediately and publish its final requirements at the end of July, giving lenders about a month to implement them.
Banks have become financially stronger in the past three years but weaker earnings could reduce their ability to withstand shocks. After testing the banks against a crisis scenario, the FPC has told them to increase their capital buffers by half a percentage point to prepare for possible turbulence that could cause bad debts to rise.