Britons holidaying in Europe this summer were handed a windfall by the Bank of England after the prospects of higher interest rates sent the pound to a seven-and-a-half-year high against the single currency.
With the euro already weakened by the Greek debt crisis, comments on Thursday by the Bank’s governor, Mark Carney, pointing to dearer borrowing around the New Year pushed sterling to levels last seen in the month following the collapse of Northern Rock in the autumn of 2007.
Visitors to Spain, France and Italy will find they get 10% more euros for their pounds than a year ago, with UK consumers also benefitting from cheaper imported goods.
On the foreign exchanges, the pound was trading at €1.4411 against the single currency, up around 0.5% on the day. It also increased in value against the US dollar and hit its highest level against a basket of global currencies since early 2008.
But the strength of sterling will make life tougher for exporters, widening the UK’s record current account deficit and making it harder for the government to achieve its aim of rebalancing the economy away from consumer-led growth.
The Resolution Foundation thinktank warned that even the limited increases in interest rates envisaged by Carney in a speech in Lincoln Cathedral on Thursday would push 1 million households into “debt peril”, with the higher cost of servicing debt offsetting the pick-up in wage growth seen in recent months.
Matthew Whittaker, the foundation’s chief economist, said: “Although the impact of higher rates on borrowing costs is likely to be limited at first, even relatively modest increases will pose a significant financial challenge for more than a million ‘highly geared’ households, some of whom are already struggling to make repayments even with rates at historic lows.”
Interest rates fell sharply between 2007 and early 2009 in response to the UK’s worst recession of the postwar era and have been pegged at a record low of 0.5% for more than six years. Carney stressed in his speech that the Bank would be cautious when the moment came to start raising rates, predicting they would peak at little more than 2%.
Even so, Resolution Foundation research conducted last year found that an increase in the base rate to 2.5% by 2018 would send the number of people who spend more than one-third of their income on home loan repayments rocketing from 1.1 million to 2.3 million – equivalent to one-in-four households with a mortgage.
Mortgage payers in “debt peril”, which the thinktank said meant they spent more than half of their post-tax income on debt repayments, will increase from 600,000 to 1.1 million, it said.
Whitaker said the chancellor needed to put in place safeguards for mortgage borrowers who have become “mortgage prisoners” – trapped on variable rates because stricter lending rules limit their options for remortgaging.
The expected rise in mortgage costs will come as the government prepares to cut tax credit payments, affecting 13 million families, and a real terms freeze on the public sector, hitting around 5.5 million workers.
Carney acknowledged the vulnerability of households to rising interest rates in his speech, noting that fixed-rate mortgages were less common in the UK than in the US. The governor said there was a “greater sensitivity” to floating interest rates, where lenders increase the cost of home loans as soon as the Bank announces a move in official rates.
If interest rates rise in line with City forecasts, more than half of the UK’s 12 million mortgage borrowers would be paying higher interest rates in a year’s time and close to three-quarters in two years’ time, Carney said.
Threadneedle Street commissions its own study of mortgage distress and found that a disturbingly high level of the UK’s total mortgage debt is held by households where loans are a high multiple of income. Households with loans worth four times their income account for 20% of total UK mortgage debt, while those with five times loan-to-income ratios account for 10% of the total.
The independent Office for Budget Responsibility has forecast that household debt will rise to a new peak in 2019 after a modest fall following the banking crash in 2008. The rise to 182% of disposable income will exceed the pre-crisis peak of 169%, according to its analysis.
A report by Moody’s, the credit ratings agency, emphasised the precarious state of many household finances when it warned earlier this week that a boom in credit card lending could quickly turn to bust.
It said credit card borrowing had increased by 7% a year since 2010 “leaving borrowers increasingly vulnerable to economic shocks”.
It added: “Low interest rates are hiding the risk to consumers, making consumer debt appear more affordable on the surface, but masking potentially negative long-term consequences.”
Carney also stressed the dangers of a strong pound to British exports, a concern shared by business groups. “Sterling has appreciated around 18% over the past two years and around 7% since the turn of the year. This will exert a drag on inflation both through lowering imports costs and by lowering world demand for UK goods”, Carney said.
However, Angus Campbell, a senior analyst at brokers FxPro, said there was an immediate benefit for British tourists travelling to the continent.
“It is tremendous for people going to the continent. [On a year ago], your holiday is going to be 10% cheaper,” he said. “We are at levels last seen before the credit crisis – 2007 was when the euro sterling [rate] was at this level. It is quite a significant breakthrough … It is a technical level that makes euro investors fear exposure to the euro even more.”