BoE Warns of Market Fragility After Brexit Vote

A further deterioration in investor appetite for UK assets,
together with a potential rise in the number of vulnerable households and
increased fragility in financial markets are among the main risks that the
Financial Policy Committee of the Bank of England (BoE) is monitoring,
following results of the Brexit referendum on June 23.

Some of the risks it had identified in connection with the
referendum “have begun to crystallise”, FPC says in its bi-annual Financial
Stability Report, released Tuesday.

The FPC had warned of channels through which the referendum
could heighten risks to financial stability, namely: the financials of the UK’s
large current account deficit, “which relied on continuing material inflows of
portfolio and foreign direct investment”; the UK commercial real estate market,
which had experienced “strong inflows of overseas capital”; the high level of
UK household indebtedness, as well as vulnerability to higher unemployment and
borrowing costs of the capacity households to service debts, and the potential
for buy-to-let investors to “behave pro-cyclically”, thus amplifying movements
in the housing markets; subdued growth in global and euro area economies;
fragilities in financial market functioning.

FPC Slashes UK
countercyclical capital buffer rate to 0%

As part of efforts to support the supply of credit and
market functioning, the FPC is reducing the UK countercyclical capital buffer
rate from 0.5% to 0% of banks’ UK exposures “with immediate effect”.

In addition, it expects to maintain a 0% countercyclical
capital buffer rate until “at least June 2017”.

“This action reinforces the FPC’s expectation that all
elements of the substantial capital and liquidity buffers that have been built
up by banks are able to be drawn on, as necessary,” it said, adding that “it
will reduce regulatory capital buffers by £5.7 billion, raising banks’ capacity
for lending to UK households and businesses by up to £150 billion.”

Markets Functioned
Well, but Price Adjustments “Possible”

The FPC noted financial markets have “appeared to have
functioned well” in the aftermath of the vote, but warned that a “further
adjustment of market prices is possible”.

A sharp rise in volatility was seen in the first half of the
year, particularly after the referendum, with the sterling exchange rate index
falling by 9% between June 23 and July 1, FPC said, as cable levels experienced
the highest level of short-term volatility in the post Bretton-Woods era.

“These moves reflect an increase in risk premia on UK
assets, a perceived weaker growth outlook and anticipation of some future
deterioration in the UK’s terms of trade and supply capacity,” FPC said.

Moreover, FPC noted that despite a slight decrease from 7.2%
of GDP in Q4 2015 to 6.9% in Q1 2016, the UK’s current account deficit remains
“high by historical and international standards”.

The financing of the deficit relies heavily on foreign
inflow of investment, which slowed down in the run up to the referendum.

Amid ongoing uncertainty, the risk premium on UK assets
could rise further and overseas investors might be deterred from investing in
the UK, which in turn would put pressure on the exchange rate, further
tightening funding conditions for UK borrowers, FPC said.

Beatrice Bedeschi


Beatrice Bedeschi

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