UK economy ‘one of the most vulnerable’ in the world due to mortgage trends, strategist says

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There’s an economic idiosyncrasy in the U.K. that makes it “one of the most vulnerable countries in the world right now,” according to an investment strategist.

Mike Harris, the founder of Cribstone Strategic Macro, argues that a major problem for Britain is that its mortgage market is “heavily short-term.” While in the U.S. and in other parts of Europe citizens like long-tenure mortgages, many Brits opt for short-term loans of less than five years. Tracker mortgages are also popular which fluctuate with the Bank of England’s base rate.

Harris told CNBC Friday that this was an issue as rate rises would immediately trigger losses to household incomes, while it might not actually deal with the issue of inflation. He explained that the U.K. was a country that “imports inflation,” so the effect of interest rate hikes by the Bank of England wasn’t simply a rebalancing of supply and demand that would slowly rein in consumer price growth.

“Here we’re actually not really dealing with a pure situation where we’re trying to slow the economy, we are ultimately trying to rebalance expectations, and the U.K. is a country that imports inflation … So we’re not effectively in a position where we’re free effectively to just focus on supply and demand,” he said.

He added: “We get stuck in a situation where global inflation is driving our inflation at this stage, we have to hit the consumer and instead of just reducing the propensity to spend in the future, we’re actually taking further money out of household income, which doesn’t happen in the U.S.”

The Bank of England raised interest rates by a quarter of a percentage point on Thursday, taking its base interest rate up to 1%. That’s the highest interest rates have been since 2009 and was the BOE’s fourth hike in a row. The central bank also forecast that inflation would hit 10% this year, with soaring food and energy prices exacerbated by Russia’s unprovoked attack on Ukraine.

Harris said he had twice requested data from the Bank of England about how much lending in the country was fixed on a two-year term and how much was set for five years, but said that he was told that the central bank did not keep that information.

Harris argued that it was “absolutely insane for a central bank to not appreciate the economic impact associated with every rate hike.” He explained that consumer behavior would unlikely change a lot in five years but it would over two years.

U.K. ‘facing the music’

According to a data from trade association UK Finance, 1.5 million fixed-rate mortgage deals are due to expire in 2022, with another 1.5 million due to do so next year.

In data released on Friday, investment platform Hargreaves Lansdown calculated that someone remortgaging at the end of a two-year fixed term deal, following the latest interest rate hike, could see their monthly payment go up by £61. If the base rate hit 1.5%, Hargreaves Lansdown worked out that could add £134 to their monthly mortgage payments. According to a survey of 2,000 U.K. adults, conducted on behalf of the platform in April, more than a third of people would struggle to afford those extra costs.

Harris said that due to the current rate raises “we’re in an environment where we’re probably going to destroy more demand than we should have because the Bank of England and [former governor] Mark Carney didn’t do their job as they should have.”

He said this dynamic was similar to that with the Federal Reserve in 2007, just before the onset of the Global Financial Crisis, as “they were allowing people to take mortgages when they knew they couldn’t repay them if house prices fell because they had to refinance so there’s an inherent unsustainability.”

Harris added that the U.K. was now in a stage where it was “facing the music.”

“I would say the U.K. is one of the most vulnerable countries in the world right now because of that dynamic and the fact that central bank governors didn’t do anything about it, they still might have some time,” he said, arguing that if policymakers had the means to extend this debt duration now, they should “actively” be doing so.

A spokesperson for the Bank of England declined to comment but pointed CNBC to recent statements by Governor Andrew Bailey and Chief Economist Huw Pill.

In the past, two-year fixed-term mortgage have been popular because they tend to be cheaper due to the shorter lending period. However, UK Finance said that the popularity of five-year agreements had been growing with 50% of fixed-term contracts in place in 2021 having this duration, while 45% were on two-year contracts.

Bank of England data from last week showed that the “effective” interest rate — the actual interest rate paid — on new mortgages increased by 14 basis points to 1.73% in March — the biggest increase since at least 2016, according to Bloomberg.

Cost of living squeeze

Speaking on CNBC’s “Street Signs Europe” on Friday, Bank of England Chief Economist Huw Pill also pointed out that the spike in inflation was being driven by external shocks.

He said it was “uncomfortable” for central bank members to be forecasting a 10% rate of inflation, which is well above the Bank’s long-term target of 2%.

“Of course that discomfort has to be seen in the context of the real impact of the cost of living squeeze on households and firms here in the U.K., it’s more painful for them than the discomfort from a policymaker point of view,” Pill added.

He explained that the Bank of England was trying to use monetary policy to try to ensure that those drivers of inflation don’t result in persistently higher prices, and create a stagflationary environment like that of the 1970s. But he said the central bank wanted to bring inflation back down to target without introducing “unnecessary volatility into the economy.”

Bank of England Governor Andrew Bailey told CNBC’s Geoff Cutmore Thursday that the U.K. was seeing an “unprecedentedly large shock to real income in this country coming from abroad,” in terms of trade issues.

Bailey also defended the central bank’s more cautious approach to raising interest rates, with three dissenting members of its MPC having argued that the BOE should be more aggressive with its hikes.

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