Rise in Interest Rates will Increase Pressure on UK Household Finances

July 11, 2022

In many countries, tighter financial conditions and lower real earnings will make it more difficult for people to afford debt, which will raise the dangers associated with global debt vulnerabilities. Through economic and financial repercussions, they endanger the stability of the UK’s financial system.

According to the Bank of England, the rise in living costs and interest rates will increase pressure on UK household finances in coming months despite aggregate household debt relative to income remaining broadly flat in recent quarters and there being little evidence of a deterioration in lending standards.

It is anticipated that the proportion of households with high debt-servicing ratios – those who are typically more likely to encounter repayment difficulties – will not rise significantly this year, in part because fiscal support measures will cushion debt serviceability in the short term. This share is anticipated to rise beyond its historical average in 2023 as households continue to feel the effects of interest rate increases and unemployment increases, but it will still be much below the heights observed before the global financial crisis.

Most UK businesses can still afford to pay their debts. However, corporate balance sheets are anticipated to be impacted by rising interest rates and input costs, weaker economic growth, and ongoing supply chain disruption. These consequences won’t affect all businesses equally. Manufacturing and transportation, two industries with high energy or fuel price vulnerability, may experience severe cost pressures. Additionally, the decline in real household earnings may result in a considerable decline in demand for non-essential home products and services. While some business failures may result from these constraints, it would take significant rises in borrowing prices or significant earnings shocks to negatively impact businesses’ capacity to service their debt on an overall basis.

The amount of debt held by UK small and medium-sized enterprises (SMEs) has increased since the COVID pandemic, although most of this new debt was given at relatively modest rates and the majority of it was fixed for six years or longer. Amidst this, it is believed that at least 70% of the current stock of outstanding SME debt was issued outside of government lending schemes, and a sizable amount of this debt is vulnerable to hikes in the Bank Rate within a year. Also, SME cash reserves are less than they were during the pandemic. SMEs account for a sizable portion of employment but a very modest portion of total corporate debt, posing little direct danger to the UK financial industry in terms of bank losses.



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