How will Brexit affect consumer credit availability and interest rates?

By Benjamin Salisbury

The decision by the UK to exit the EU, also known as Brexit, has caused global shockwaves, politically and economically. In the aftermath of the vote, the Bank of England is taking measures to ensure that credit will be available.

Before the vote, the Bank of England's Financial Policy Committee (FPC) stated that it had "identified in March the risks around the referendum on the United Kingdom's membership of the European Union as the most significant near-term domestic risks to financial stability."

The morning after the vote, when the pound dipped by 9% in just five hours, Mark Carney, the Governor of the Bank of England stated, "Inevitably, there will be a period of uncertainty and adjustment. Some market and economic volatility can be expected as this process unfolds."brexit-and-credit-availability

And indeed, the Bank's bi-annual Financial Stability Report published on 5 July said that "there is evidence that some risks have begun to crystallise."

"The economic outlook has deteriorated and some monetary policy easing will likely be required over the summer," Carney said in a speech delivered on 30 June.

Credit availability for businesses and consumers is a key concern. "By increasing economic uncertainty, the Brexit vote raised the risk that banks would seek to establish tighter standards for credit provision to the household sector," Brian Lawson, Economic and Financial Consultant for Economics & Country Risk at IHS Global, said in an emailed reply to questions.

Bank expects to take measures to ensure availability of credit
In the aftermath of the vote, the BoE's Carney hinted that an interest rate cut is the most likely first step in the Bank's reaction to Brexit. He also noted the disadvantages of cutting interest rates below zero, which some other countries have done. He said that could "perversely" reduce the availability of credit.

However, he said the Bank of England "will not hesitate to take additional measures as required as those markets adjust and the UK economy moves forward." Those additional measures could include resuming the Bank's £375bn quantitative easing (QE) programme, in which the central bank creates new money electronically to buy financial assets, and its Funding for Lending Scheme (FLS), designed to incentivise banks and building societies to boost their lending to the UK economy.

Additionally, he said, the Bank "stands ready to provide more than £250bn of additional funds through its normal facilities. We expect institutions to draw on this funding if and when appropriate in order to provide credit."

The Bank's report lived up to Carney's claims that the Bank would take measures to ensure credit availability. The report said the FPC reduced the amount of capital that banks must hold as a hedge against cyclical upturns in the credit cycle. The rate had gone up in March from 0% to 0.5%, but it will return to 0% until June 2017, barring surprise events.

The banks can release £5.7bn of capital, which, the Bank of England said, translates into £150bn of new lending available to the wider economy. The report advised that capital buffers built up in the good times are there to be used in stressed economic conditions to ensure lending continues and to give households and businesses the confidence to borrow and not postpone economic decisions.

"Today's move cannot stop banks tightening their credit standards if they deem this prudently necessary," said Lawson. "What is does is to free up sizeable new lending capacity from a regulatory viewpoint within banks' current capital bases."

Consumers with high debt may struggle more than ever to repay
The Financial Stability Report noted that UK household debt has fallen since the financial crisis, but remains higher than historical levels. Tougher income-to-loan mortgage ratios have curbed mortgage debt, but consumer credit, including credit cards, overdrafts and personal loans, has grown between 2014 and 2016.

"The ability of some households to service their debts would be challenged by a period of weaker employment and income growth," the Bank's report said.

Will the base rate go up?
Though Carney hinted that an interest rate cut was likely to be the first step in the Bank's reaction to the Brexit vote, the fall in sterling means that imports become more expensive, pushing up inflation, which may eventually encourage the Bank to raise interest rates.

Carney and the Bank's Monetary Policy Committee could face a dilemma in the coming months balancing potentially rising inflation with the need to limit any interest rate rises to protect the still-fragile economic recovery.

The base rate has limited effect on credit card rates, but tougher credit conditions could make it harder to get any credit. The Bank will make its next decision on interest rates on 14 July. For now, a cut from the current 0.5% to 0.25% looks likely in July or August.

See related: What Brexit might mean for credit card consumers

Published: 6 July 2016