Bank and Treasury cool mortgage market

Mark Carney wants to turn up the heat in the business lending market

Amid concern that a housing market bubble may be in the making, the Treasury and Bank of England have today removed an important incentive to banks to supply cheap mortgages.

They have done this by modifying the Funding for Lending Scheme. This was launched in July 2012 and in the first 11 months saw 28 banks borrow £17.6bn from the Bank of England, at an interest rate often as low as 0.75%.

The scheme was designed to encourage mortgage lending and lending to businesses.

So far, it has been much more successful in stimulating the supply of mortgages: approvals of mortgages are currently running at a monthly rate a third higher than in 2010-11, though they are still almost 40% below the average monthly supply in the 10 years before the 2007/8 crash.

And the typical price of mortgages has come down by more than a percentage point.

When I speak to banks and housebuilders, they all say that the cause of the current momentum in the housing market is due much more to Funding for Lending than the government's two, and more controversial, Help to Buy schemes.

However, business lending is still contracting.

So the Bank of England and Treasury have made two important modifications to Funding for Lending.

Each bank's entitlement to cheap loans from the Bank of England is currently based on the quantity of loans the bank makes to businesses and households. But from next year, the entitlement will be assessed only on the volume of business loans made: lending to households will not unlock any new cheap funding from the Bank of England.

Or to put it another way, if banks want to maximise their access to the cheap finance, they will have to lend as much as they can to businesses.

And the second modification is that the cost of borrowing from the Bank of England will cease to be variable. It will be fixed at 0.25% plus Bank Rate - or 0.75% - which is the very cheapest rate.

That lowest possible rate will no longer be available only to those who lend more than their customers are repaying (those who increase net lending).

Anyway, the point of all this is to turn down the heat under the mortgage market, and turn it up a bit in the business lending market.

Why?

Well, the UK economy is currently growing faster than all the major developed economies. But that rate of growth won't be sustained for long if it's too dependent on same-old, same-old household spending, combined with a traditional revival in the housing market, while business investment and exports remain flat as a pancake.

UPDATE 13:05

Although the Bank of England may be right that the change to Funding for Lending has not increased the cost of money, that amendment plus other reforms announced today may lead to a pronounced contraction in the supply of cheap mortgages.

The Bank of England is making mortgages more expensive for banks to provide by ending the exemption they enjoyed from the capital charge imposed on them: it means that banks will only be able to make new loans to households if they hold adequate expensive capital.

Or to put it another way, in a world of scarce and expensive capital, this change makes mortgages scarcer and more expensive - though the precise short-term impact is hard to gauge.

And the Bank has also made clear that it will pay particular attention to whether banks' customers can repay their mortgages when conducting thorough assessments or stress tests of banks' strength.

That will act as a deterrent to banks providing loans with a high value relative to the property value, even if those mortgage loans contain an element of state guarantee via the Help to Buy scheme.

In the round, therefore, the Bank of England does seem to have put a firm push on the brake to prevent the housing market motoring away.