The International Monetary Fund (IMF) has recently expressed concern to the Bank of England, highlighting the potential risks associated with the high proportion of fixed-rate mortgages in the U.K. With a substantial number of homeowners shielded from the impact of interest rate hikes, the IMF warns the Bank of England of looming threats to consumption, housing prices and financial stability as tighter monetary policies begin to take effect.
The IMF’s forthcoming World Economic Outlook chapter reveals that the U.K. has one of the highest percentages of fixed-rate mortgages globally. This surge in popularity occurred in the decade leading up to the onset of the Covid-19 pandemic. Hence, more than 80 percent of home loans in the U.K. are for fixed terms, usually for periods of five years or less. However, the IMF’s concerns arise as over 1.5 million fixed-rate mortgages are set to mature in 2024.
Impact of monetary policy
The Bank of England’s monetary policy committee raised interest rates 14 times between December 2021 and August 2023. However, borrowing costs have remained unchanged at 5.25 percent despite the decrease in the annual inflation rate from 6.7 percent to 3.4 percent since last summer. Hence, the IMF underscores the impact of the Bank of England’s higher interest rates on the country’s economy, especially in light of a high proportion of fixed-rate mortgages.
The IMF underscores the weakened transmission of monetary policy in economies with a high prevalence of fixed-rate mortgages. It emphasizes that over-tightening or maintaining high rates for an extended duration could exacerbate risks, leading to reduced consumption and increased defaults. As fixed-rate mortgages reset over time, households may face financial strain, especially considering the short fixation periods.
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Potential financial instability
The IMF report highlights the global trend of households capitalizing on low-interest rates to secure mortgages before and during the pandemic. However, the combination of low rates and structural changes has propelled rapid growth in house prices. This leads to concerns of overvaluation. Should interest rates remain high for a long period of time, overvalued markets are more likely to correct.
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