U.K. Financial Stability At Risk?

Earlier this week, the BOE published its latest financial stability report and warned the public of the dangers that may arise if bond yields spiral out of control. But you may be surprised to hear that the root of the problem doesn’t lie in the U.K. –BOE officials are afraid that the recent moves in U.S Treasuries could cross the Atlantic and translate to higher borrowing rates and big problems for the U.K. financial system.

The central bank already plans to ask for the help of the U.K.’s financial regulators, the Prudential Regulation Authority and the Financial Conduct Authority, to determine how large increases in long-term borrowing costs might affect borrowers and financial institutions.

In the central bank’s own assessment, it found that U.K. borrowers are vulnerable to a rise in interest rates. By its estimates, a 2% rise in interest rates would force a whopping 20% of mortgage borrowers to find a new way to meet their mortgage payments! Uh oh!

What’s particularly concerning is that mortgage approvals in the U.K. have been on the rise lately. In fact, according to the British Bankers Association’s latest report, homebuyer mortgage approvals just hit a 16-month high at 36,102 this month. I hate to break it to these guys, but with interest rates threatening to climb higher, it’s starting to look like now might not be the best time to get a mortgage!

Why have bond yields been so volatile lately, anyway? And can we expect this behavior to continue?

Let’s face it, the past few weeks have been absolutely nuts in the financial markets. With the Fed confirming that it plans to cut back on its asset purchases, yields on U.S. debt have risen to two-year highs.

But why does the U.K. care about what’s happening in the U.S.? Well, to put it simply, if yields in the U.S. (the world’s largest economy and a financial superpower) were to rise, it would push up borrowing costs in other countries, including the U.K.

As though the potential risk to borrowers isn’t bad enough, the government also announced an additional 11.5 billion GBP in spending cuts. In the government spending review, Chancellor George Osborne declared that another round of austerity measures are necessary in order to keep the government deficit in check.

This fresh batch of spending cuts is set to take effect from 2015 to 2016, just before the next U.K. general election. The British government plans to remove the automatic annual pay increases of public sector workers, put a cap on total welfare spending, and enforce a tougher system for jobseekers and unemployment claimants.

I know what you’re thinking… Additional austerity measures combined with rising borrowing costs seems like a recipe for disaster! After all, spending cuts will end up eating a larger chunk of overall economic growth while higher loan rates could undermine the effect of the BOE’s stimulus efforts. Yikes!

It’s probably no surprise that the pound sold off heavily against its counterparts in the hours that followed the release of the BOE financial stability report and the government spending review. GBP/USD made a strong break below 1.5400 major psychological support and reached the 1.5300 area while GBP/JPY crashed below the 150.00 handle. This goes to show that traders already started to price in bleak U.K. growth expectations, as the country’s ailing finances puts their economic recovery at risk.

Of course, Chancellor Osborne insisted the economy was on the right track, as he said that “Britain is moving out of intensive care and moving from rescue to recovery.” Do you think that’s the case or is the U.K. about to suffer another financial downturn? Let us know by voting through the poll below!