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BoE warns household debt a risk to sustained recovery

THE Bank of England's Financial Policy Committee has highlighted high levels of household debt and soaring house prices as potential risks to a sustained recovery.

Minutes from the FPC's most recent meetings were published yesterday and also showed policy makers differed over what they thought the best ways were to stop people taking on mortgages that may be too large for them to service.

The FPC, which includes BoE Governor Mark Carney and deputy governors Ben Broadbent, Sir Jon Cunliffe and Andrew Bailey, stated the recovery in advanced economies has continued but warned that financial stability risks remain.

Among those risks was mortgage lending which the FPC minutes note is the largest single asset class on the balance sheets of major UK banks, while mortgage borrowing accounts for the largest share of household debt.

The FPC recently said it would only allow 15 per cent of new mortgages to be at multiples of higher than 4.5 times a borrower's income while also adding more affordability checks for all lending.

The minutes from the June meeting showed policymakers had also considered setting a lower ratio as the threshold but relaxing rules to allow more mortgages above that level.

The record showed most policymakers agreed a shortage of housing was a major driver behind rising prices, although one suggested big rises had also taken place in countries without a shortfall in stock.

The committee also discussed the risk to financial stability from household debt and noted international evidence of a strong link between rapid, ­widespread increases in that and financial crises.

The minutes said: "In the United Kingdom highly-indebted individuals had had to adjust spending more sharply during the recession than other households. These studies were supported by survey evidence on the ­likelihood that some households would have to take some kind of action, such as curtailing ­significantly their spending or seeking to earn more, if interest rates were to rise sharply.

"The likelihood that households would need to respond in this way, leading to instability in spending and demand which could in turn threaten financial stability, was materially greater for highly-indebted households subject to adverse shocks to incomes or interest rates.

"Further, highly-indebted households were more likely to fall into arrears and trigger a risk of default on required mortgage payments, creating a direct risk of losses for banks."

One recommendation in the minutes was that lenders should not advance more than 15 per cent of the total of new mortgages at a loan to income ratio of more than 4.5.

A second was mortgage lenders should apply an interest rate stress test when assessing affordability. That would involve considering whether a borrower could still afford repayments if interest rates were three percentage points higher at any point over the first five years of the loan.

The committee agreed to monitor future housing developments and adjust its policy as necessary.

The minutes said: "The committee judged that it was acting early, in a graduated and proportionate way, to reduce the risk that more severe action would be needed at some point in the future."

The minutes also revealed for the first time discussions between the BoE and Britain's finance ministry dating back to September 2011 over how to protect against the risk of a eurozone break-up.

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