Bank of England warns of Brexit woes ahead

Brexit, UK, European Union, EU

The Bank of England has warned that June’s Brexit vote could impact the cost and availability of credit for UK borrowers.

The Bank labelled the referendum on the UK’s membership of the European Union as the most significant near-term domestic risk for financial stability, adding that a vote to leave could spill over into the euro area, further diminishing its growth prospects.

The statement by the Financial Policy Committee accompanied details about the 2016 stress test, which will be the toughest yet in its three-year history.

In this year’s scenario, global GDP growth reaches a bottom of -1.9 per cent, as it did during the 2008 global financial crisis, and the price of oil falls to $20 a barrel. In the UK, residential property prices fall by 31 per cent.

In October, the Bank of England announced it would adapt the severity of the test according to policymakers’ assessment of risk levels across in what it calls the “annual cyclical scenario” framework.

The Financial Policy Committee said uncertainty created in the lead up to the vote on June 23 had been most marked in sterling spot and options markets.

It said pressures on borrowers had the potential to reinforce existing financial stability vulnerabilities, in particular the UK current account deficit, which it said remained high by historical and international standards.

“The financing of that deficit is reliant on continuing material inflows of portfolio and foreign direct investment,” says the Financial Policy Committee. “Those flows have contributed to the financing of the public sector financial deficit and corporate investment, including in commercial real estate.”

It added that heightened uncertainty could test the capacity of those funders at a time when advanced economies are already showing signs of fragility when it comes to liquidity.

The Financial Policy Committee praised the Bank of England’s decision several weeks ago to introduce three liquidity injections into the UK market around the referendum in the form of indexed long-term repo operations.

These give banks, building societies and broker-dealers access to cash reserves using various collateral and will take place on June 14, 21 and 28.

The 2014 stress test had shown the banking system was strong enough to withstand risks associated with June’s referendum and to continue to serve households and businesses, the Financial Policy Committee says. It adds that the resilience of banks has improved in the two years since.

Other domestic risks raised by the Financial Policy Committee in its stress testing statement were credit conditions and buy-to-let mortgage lending.

“With a relatively high level of household indebtedness, debt serviceability remains vulnerable to shocks to interest rates, employment or growth,” the statement said.

The committee also said it remains alert to potential threats to financial stability from rapid growth in buy-to-let mortgage lending, which had risen 11.5 per cent in the year to 2015 Q4.

“The macroprudential risks centre on the possibility that buy-to-let investors could behave pro-cyclically, amplifying cycles in the housing market, as well as affecting the resilience of the banking system and its capacity to sustain lending to the wider real economy in a stress,” says the Financial Policy Committee statement.