'Significant' threat emerges of sharp rise in interest rates, warns Bank of England

Increase would affect debt-laden households, banks and finance firms

The Bank of England has warned over the "significant" threat from a sharp rise in interest rates to debt-laden households, banks and finance firms.

In its quarterly financial stability report, it called for City regulators to assess how vulnerable borrowers and financial institutions will be to a sharp rates rise and report back in September.

The Bank warned that borrowers would face "significant distress" and "risks could crystalise" if global long-term interest rates were to rise from their current historic lows.

UK borrowers currently benefit from the lowest interest rates on record, with the Bank's base rate stuck at 0.5 per cent since 2009, whilst other central banks around the world have also pushed rates to record lows.

This has allowed cash-strapped households to keep on top of mortgage repayments, despite a fall in real incomes, with lenders also relaxing debt demands through forbearance.

The Bank said: "The significant cohorts of UK borrowers could experience financial difficulties if interest rates were to rise during a period of subdued income growth.

"A rise in interest rates without a strengthening in income could significantly increase borrower distress and losses to banks."

It added that UK household debt remains high as a proportion of income at around 140 per cent, with UK bank lending to households and non-financial firms at around £1.4 trillion.

Around 9 per cent of UK mortgage holders will have to take action - such as working longer hours, cutting back on essentials and changing mortgage - if rates were to rise by just one percentage point, it said.

Sir Mervyn King warned in his last public appearance as governor yesterday that many homeowners in their thirties and forties would not survive if interest rates returned to normal.

He said: "I think the idea we are about to return to normal levels of interest rates is premature, and one of the reasons we are not about to return is precisely because so many households have such a high level of household debt."

A rise in rates could hike bad debt losses at banks, the Bank said today, as well as increase their funding costs.