MNI: Economic Outlook Worse, Stability Risks Rise - BOE

The Bank of England's Financial Stability Report saw deterioration in the domestic and global economic outlook, with downside stability risks rising.

Stressed commodity markets, tightening financial conditions and the vulnerabilities of the property market with interest rates rising were all risks put in the spotlight in the report. Nevertheless, UK banks were deemed to be resilient to the increasing stresses.

The BOE's Financial Policy Committee announced that it was raising the Counter-cyclical Capital Buffer (CCyB), the 'rainy day' capital buffer, from 1% to 2% in July 2023, taking it back to a normal level and forcing banks to enhance their capital provisions. 

MARGIN CALLS RISE

The surge in commodity prices and accompanying supply shortages have resulted in a sharp rise in margin calls for commodity funds and these disruptions in commodities have knock-on effects in other financial markets and through into the real economy, the Bank noted.

The report cited the complex inter-linkages between commodity markets and the rest of the financial system through financing, derivatives and infrastructure and warned that a swathe of commodity firms were vulnerable.

The FSR said there was a significant risk of further commodity market disruption and that "a range of highly levered financial and non-fiancial commodity markets participants are vulnerable to a sudden increase in liquidity demand."

UK SME's VULNERABLE, BANKS LESS SO

The FSR identified vulnerabilites of smaller UK firms, with SME debt now above pre-Covid levels, although much of the debt was taken out at low rates for six years or more.

WIth SMEs making up only a small proportion of bank lending the FPC judged "that major UK banks are resilient to domestic debt vulnerabilities."

Similarly, with some 80% of UK household mortgages on fixed rates there is some initial protection to higher interest rates and the households with the tightest budgets tend not to be mortgagees.

The BOE noted that household debt servicing costs have only returned back towards long run averages and that interest rates would have to exceed market expectations by a considerable margin, with the policy rate rising by another 2 to 2.5 percentage points to drive servicing costs up to previous peak levels.

The FPC concluded that debt servicing costs remained manageable for most firms and households but it stressed that the downside risks, including from more persistent than expected inflation, "could adversely affect UK financial stability."