"The high level of UK household indebtedness, the vulnerability to higher unemployment and borrowing costs of the capacity of some households to service debts, and the potential for buy-to-let investors to behave procyclically, amplify movements in the housing market."
The above quip is not mine, but a bullet point from the Bank of England's (BoE) Financial Stability Report released just after the UK voted to leave the European Union in June. After a blip, recent data suggests house prices were on the rise again, ignoring Brexit angst and thus continue to represent a threat to financial stability.
The BoE, however, has no intention of using interest rates to temper the housing market, as was typical before the Global Financial Crisis of 2008-09. And this is not just a British phenomenon.
Indeed, it seems central banks' thinking is that the benefits of the standard policy response are currently outweighed by the negative impact on other macro variables, such as inflation, economic growth and unemployment (eg see Williams and also Svensson).
Hence, the policy response to signs the housing market is overheating comes from the macroprudential toolkit. Perhaps though, the financial markets will do some of the tempering for the BoE.
Prime Minister Theresa May's announcement at the Conservative Party Conference that Article 50, which marks the start of Britain's talks to leave the EU, will be invoked by March 2017, set off political posturing on both sides of the Channel that currently makes 'Hard Brexit' – the UK leaving Europe's single market – the more likely scenario.
Taking the brunt of this chatter is the pound. Using the BoE's trade-weighted index, sterling is 15% weaker since the vote and around 2.5% weaker since the May's announcement on 5 October.
The result is rising inflation expectations. Actual inflation has hardly had a chance to respond as the latest Consumer Price Index (CPI) reading shows, but this is expected to follow in 2017, with some forecasting 3% year-on-year increases.
Swap rates are a useful funding cost proxy for mortgage providers. In simple terms, a swap rate is the fixed interest rate that the receiver demands in exchange for the uncertainty of having to pay the short-term Libor (or floating) rate over time.
One element of a swap rate's make-up is an inflation premium. Hence, as inflation expectations have risen with pound's depreciation, so have swap rates. If these continue to rise and mortgage providers decide to pass on the increase, then housing finance will tighten regardless of central bank inaction. Of course, how much tightening the BoE will allow is another matter.
One way of considering mortgage financing conditions is through a secured lending spread. This is the difference between the "risk-free" overnight index swap rate (OIS) and equivalent swap rate tenor.
So, the two-year secured lending spread is just the difference between the two-year OIS rate and the two-year swap rate. The wider the spread, the tighter funding conditions. Although recent widening has occurred, it is currently narrower than the pre-Brexit vote peak and much narrower than during the 2008 crisis.
Another point to consider is the real rate on a mortgage (i.e. inflation adjusted). If this becomes too low, mortgage providers may be forced to defend their real profits by hiking their offerings again without any action from the BoE.
This and/or too wide a lending spread might provoke a BoE reaction if the housing market were to slow too quickly and introduce financial instability. It could, for instance, decide to expand the term lending scheme to mortgage financing or the Bank could directly purchase mortgages.
After all, part of the US Federal Reserve's quantitative easing programme included buying newly minted mortgage-backed securities (MBS). It remains to be seen how the next 12 months unfold, as well as the BoE's response to it.
Marcus Dewsnap is a senior analyst at Informa Global Markets (IGM), which he joined in 2010. He primarily spends his time looking at the global macroeconomic landscape, monetary policy and the impact on global fixed income and foreign exchange markets, with a good dose of commodity markets thrown in. Prior to IGM, Marcus spent 10 years producing live business and financial TV programmes at CNBC and Bloomberg, during which time he also attained a masters degree with distinction in economics.