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| Storm clouds are gathering over the UK economy CREDIT: BARCROFT |
TThe Bank of England’s Financial Policy Committee (FPC), which is in charge of overseeing UK financial stability, has highlighted the biggest risks facing the economy in the wake of the Brexit vote. Here are the top five:
Household indebtedness
While household debt has come down from its pre-crisis peak of 150pc of disposable income to around 132pc in the first quarter of 2016, the Bank warned that ratios remained “high by historical and international standards”. Record low interest rates have kept borrowing cheap, the Bank said.
However, it warned that the “ability of some households to service their debts would be materially affected in the event of weaker unemployment and income growth”.
In other words: elevated levels of household debt aren’t necessarily a problem on their own. It becomes a problem when people start losing their jobs.
The Financial Stability Report highlighted that some of these fears may have started to manifest.
There was “growing evidence” that uncertainty about the referendum had led to delays to major economic decisions, which past evidence suggested could increase unemployment.
“There are early signs that these effects have continued since the referendum.”
The FPC said the policies it introduced to restrict growth in the number of “vulnerable households” had helped, such as ensuring that no more than 15pc of new mortgages are given to people borrowing more than 4.5 times their income.
However, the FPC also noted that this had also led to increased “bunching” of mortgage lending just below the 4.5 times income limit. “The FPC is monitoring closely the number of potentially vulnerable households,” it said.
Commercial property
Six months ago, the FPC warned that commercial property prices were rising at a rapid pace at the same time rental yields were falling.
Transactions had already dropped sharply ahead of the Brexit vote. Policymakers noted that since the referendum, share prices of UK real estate investment trusts had fallen sharply.
The FPC warned that these moves could hit activity in the real economy because many companies use commercial real estate as collateral to access finance.
The Bank’s analysis showed that 75pc of SMEs that borrow from banks use commercial property as collateral in this way.
While these companies have greater access to cheap credit in an upswing, the Bank noted that in tougher times “companies may be unable either to refinance existing debt or to borrow to invest in new productive opportunities”.
Research by Bank staff suggests that every 10pc fall in UK commercial real estate prices is associated with a 1pc decline in "economy-wide investment".
Current account deficit
Britain’s “other” deficit has come under greater scrutiny in recent years.
The deficit, which measures trade, overseas income and transfers to bodies such as the EU, stood at 6.9pc of gross domestic product (GDP) in the first quarter, close to its record high.
The size of the deficit means its financing relies on “continuing material inflows” of foreign direct investment.
According to the Bank, overseas companies account for roughly half of UK commercial real estate transactions since 2013, making this sector “particularly vulnerable to a change in investor preferences”.
If foreign investors start to sell UK assets, this will put pressure on the pound, which has already fallen sharply in the wake of the Brexit vote. Policymakers said a “prolonged period of heightened uncertainty” that could stem from the Brexit vote means there is “a risk that overseas investors could continue to be deterred from investing in the UK”.
Global economy
Uncertainty could pose further risks to the global recovery, according to the FPC. The Brexit vote had left eurozone countries particularly vulnerable, with many banks in the bloc still dealing with a substantial number of bad loans on their books.
As investors flee to safe assets, the Bank said a stronger dollar could spell trouble in emerging markets. It noted that non-financial corporates in emerging economies had close to $1 trillion of outstanding dollar-denominated debt securities.
“Currency depreciations against the US dollar would increase the cost of servicing these debts,” it said.
Fragile markets
Financial markets are fragile, volatile and vulnerabilities could hamper funding to the real economy.
While the committee noted that markets “appeared to function well” following the EU referendum result, it said the liquidity of core markets remained “fragile”.
The FPC said a “sustained” period of illiquidity could result in “a loss of confidence in financial markets’ ability to support funding to the real economy or facilitate the transfer of risks”, making it tougher for UK companies to borrow.
