Speaking at the Mansion House, Bank of England Governor Mark Carney began by providing a brief numeric review of the current state of the UK Economy: The Output Gap was currently estimated, he said, at about 1 to 1.5% GDP; the Current Account Deficit is running at the largest levels it has ever seen; Household Indebtedness [a figure critical in assessing MacroPrudential policy] is at 140% of Disposable Income; Sterling appreciated by about 10% over the last year; the National Investment Income account has seen a 3% swing over the past year.
He saw the financial markets as expecting the Bank Rate to rise by about 2.25% over the next 3 years, but noted that the timing of first rate increase is less important than the path that interest rates will take (the quantum of initial rise, the spacing, quantum and direction of subsequent interest rate movements). He noted that the vulnerability in financial markets exists across all asset classes with the implied volatilities in each asset class being well below their long-term averages. He noted particularly that the spreads in high-yield and peripheral bond markets (i.e. markets for bonds in 'peripheral' countries such as Portugal, Spain or Greece) have collapsed.
Across the UK, residential property values have risen by about 10% over the past year, and are now approximately at their 2007 levels. That they will continue to rise thus is most strongly expected for locations outside London; however, mortgage loan originations appear to have slowed, a trend that might reflect increasing levels of compliance with the Financial Conduct Authority’s (FCA) new Mortgage Market Review underwriting requirements. He noted also that Housing supply appears short, by about half the level required to keep real house prices rising at less than 1%, and in this connection cited a study conducted at the Bank a few years ago. While the Bank thus keeps a very close watch on asset prices - both financial and real - it does not target <asset price inflation. He emphasized, of course that it does worry about indebtedness, especially of the type that fuels residential property price inflation, as such indebtedness could stand to threaten resilience in the core of the banking system (credit to households represents most of UK banks’ lending).
As household indebtedness is already 140% of income, noted in the beginning of the speech, this trend worries the bank in view of its potential to threaten financial system resilience. Another way to look at this from the perspective of the real economy would be to note that a durable expansion requires that home mortgages be serviceable throughout their lifetimes, not just when interest rates happen to be at historic lows, as right now. He noted also that debt-related vulnerabilities build up in the financial system over a longer period than business-cycle fluctuations, thus credit cycles are distinct from business cycles. A key point he made was in emphasizing that if monetary policy were to be used to target real asset prices (such as those of homes), then the risk of "undershooting" on the consumer price inflation target becomes more significant, thus damaging growth in the real economy.
Much speculation has already begun on what the message regarding the timing and pace of possible interest rate rises will actually be. An excellent analysis of what he said has been posted by Frances Coppola: What Mark Carney Did and Didn't Say About UK Interest Rates".