After a long-anticipated BoE presentation of data the wait is finally over. For the first time the BoE released concurrently its interest rate decision, the quarterly inflation report and the minutes of the MPC meeting.
As expected, there was no big surprise after the BoE keep interest rates at record low 0.5%. Only one member out of the nine-strong MPC has voted for a rate rise. Although the chances of an interest rate increase this year have been ruled out, the dissenting voter and the mood painted by Mark Carney indicate that 2016 will be the year when we finally see the UK beginning to embark on the next stage of economic recovery with interest rates increase.
Are we seeing signs of change that will justify the increase? If so, what now?
There have been a number of false starts but we are now seeing signs of the effect of low interest rates. Consumer spending growth has been on a steady upward trajectory with retail, distribution and other services showing an annual growth rate of c.5% since early 2014. Moreover, UK construction sector has demonstrated a continued rebound after Markit/CIPS released June data, which showed UK Construction Purchasing Managers’ index rising to 58.1 in June, up from 55.9 a month earlier.
With Sterling riding high reaching the strongest level since 2007 against the euro, a hawkish outlook for UK monetary policy is more prominent than ever, as evidenced by the first split vote in the committee in 2015. This interest rates rise, when it comes, will have a profound impact on retail bank businesses, both assets and liabilities.
Let’s consider mortgage lending for instance. Mortgages are the largest driver of retail bank revenues, with up to 75% of revenues coming from this revenue stream. Lenders have significant exposure to rate increases, as 74% of customers have rates >2% above bank base rate compared to 7% in 2007.
As property prices increase and customer loan values decrease, customers are released from trapped mortgages. This results in increased customer sensitivity to price changes and more volatile approach in selecting the mortgage provider. In anticipation of a rate increase consumers are being encouraged to get on the property ladder by lenders offering low rates in a race to gain market share.
On the liability side, banks are now facing a new set of opportunities and challenges as the economy begins to recover. Whilst dealing with the outlook of an interest rate increase, banks must protect their margins, answer regulatory requirements (particularly Basel III) and grow stable forms of deposits to support asset growth.
Having spent 4 years as Head of Deposits and Current Accounts at Bank of Ireland and experienced a unique challenge at the height of the financial crisis, the capability to bring business, technology and analytical solutions to banks in deposits management is indeed important.
Most banks have completed the downward repricing of deposits and repaired, somewhat, the negative jaw that existed as rates were falling. However, unfortunately many banks are also “deferring” deeper analytics to support strategies for the upward rate cycle. The reason for this deferral is the lack of precision on the timing of rate changes. This short-term thinking generally leads to longer-term issues.
To capitalise on rate increases, banks need to have a deeper analytical understanding of changes, their portfolio and future customer bases. Progressive banks are now adopting specific analytical strategies ensuring that they optimise both retention and acquisition strategies to ensure they meet dual objectives of the customer and shareholder.
Damian is a career banker with more than 25 years of experience. He spent most of his career with Bank of Ireland where he held a number of senior roles, including Head of Deposits and Current Accounts, Head of SME Banking and Head of Customer Management and Customer Analytics. At Nomis, Damian is Managing Director responsible for the APAC region.