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05 July 2016

Stiff Upper Lips at the Bank of England: July Financial Stability Report

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Graham Bishop reviews the Bank of England July Stability Report.

Today’s report reveals the Bank’s fears:

“Consistent with its remit, the FPC identified in March the risks around the referendum on the United Kingdom’s membership of the European Union as the most significant near-term domestic risks to financial stability. The Committee had identified the following channels through which the referendum could increase risks to financial stability:

• The financing of the United Kingdom’s large current account deficit, which relied on continuing material inflows of portfolio and foreign direct investment;

• The UK commercial real estate (CRE) market, which had experienced particularly strong inflows of capital from overseas and where valuations in some segments of the market had become stretched;

…The FPC has monitored these channels of risk closely. There is evidence that some risks have begun to crystallise. The current outlook for UK financial stability is challenging.”

The Bank highlighted the UK’s historically high current account deficit, especially the swing in primary income from years of big surpluses to significant deficits. In effect, the “Hedge Fund UK” now finds its earnings have fallen below its cost of capital – a fatal problem if it persists.

Last week, Singapore’s United Overseas Bank has said it would temporarily halt lending against homes in London, having been a major provider of mortgages against British properties. The “stretched CRE market” has been particularly hard hit by Brexit: “Foreign inflows of capital to the UK CRE market fell by almost 50% in the first quarter of 2016. More recently, share prices of real estate investment trusts have fallen sharply, reflecting the risk of future marked adjustments in commercial real estate prices.”

Sterling continues to crumble this morning amidst news that Standard Life has cut the value of it CRE fund by 5% and suspended redemptions for 28 days. Foreign investors have just taken a combined currency and valuation hit of more than 15% - and now they cannot even have their money back. Is this a foretaste of the Brexit consequences for "Hedge Fund UK"?

What are the Brexiteers plans to deal with this entirely foreseeable impact on the well-known fragilities of the UK?

© Graham Bishop

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