By David Milliken, Huw Jones and William Schomberg

LONDON (Reuters) -Britain’s economy is so far proving resilient to a surge in interest rates over the past year and a half, but it will take time for the full impact to feed through, the Bank of England said on Wednesday.

The Bank last month raised rates to 5%, up from 0.1% at the end of 2021, raising concerns about a hit to households, businesses and the broader financial sector that could push the economy into a recession.

But in a half-yearly assessment of the health of the financial system, the BoE said there was no reason for alarm.

“The UK economy and financial system has so far been resilient to interest rate risk,” BoE Governor Andrew Bailey told a press conference.

“We will continue to monitor credit conditions for any signs of tightening which are not explained satisfactorily by changes in the macroeconomic outlook.”

The proportion of households with heavy mortgage burdens was rising. But even considering the higher cost of living – with inflation at 8.7% in May – it was likely to remain below the peak seen in 2007.

On Tuesday, average interest rates for new two-year fixed-rate mortgages – the most common form of housing finance – rose above their peak following last September’s mini-budget to a 15-year high, according to data provider Moneyfacts.

Britain’s finance industry estimates 800,000 households will need to refinance onto more expensive mortgages in the second half of 2023, and a further 1.6 million in 2024.

The Bank said the typical mortgage holder refinancing later this year would pay an extra 220 pounds ($285) a month, and that, by the end of 2026, nearly 1 million households would be paying at least 500 pounds a month more.

The number of households spending more than 70% of their income on mortgage payments, after tax and other essential spending, is on course to rise to 650,000 by the end of the year, 2.3% of the total and lower than the 3.4% peak in 2007.

Consumer credit is a bigger source of trouble, with around 10% of households spending more than 80% of income after taxes, essentials and housing costs on servicing debt, up from 9% a year ago.

UK BANKS ‘ROBUST’

The BoE said British banks were less exposed than households to the adverse effects of higher interest rates, especially compared with financial institutions in other countries, while the corporate sector remained “broadly resilient”.

“Nevertheless, higher financing costs are likely to put pressure on some smaller or highly leveraged firms,” it added.

The BoE saw particular risks in global commercial real estate and from corporate borrowing in the private credit and leveraged lending markets.

Britain’s eight largest lenders all have enough capital to cope with higher interest rates, and no financial need to keep down rates for savers or treat borrowers harshly, the BoE said following its annual ‘stress test’ of the sector.

“Major UK banks’ capital and liquidity positions remain robust and profitability has increased, which enables them both to improve their capital positions and to support their customers.”

Bank shares rallied on the prospect of bigger payouts to shareholders.

However, recent data has shown the biggest year-on-year fall in house prices since 2011 and mortgage lending has fallen sharply over the past year.

“Many (lenders) are cutting margins in an attempt to maintain business levels, and they may have to revisit their criteria if they hope to maintain a healthy level of lending,” said Simon Gammon, managing partner at mortgage broker Knight Frank Finance.

The BoE’s Financial Policy Committee left banks’ counter-cyclical capital buffer, a tool used to manage risk and lending over the credit cycle, unchanged at 2%.

The Bank added that, following the collapse of Silicon Valley Bank, it was working with the finance ministry to ensure that there were options to smoothly wind up small banks that were exempt from some requirements applying to larger ones.

($1 = 0.7726 pounds)

(Additional reporting by Andy Bruce, Suban Abdulla, Farouq Suleiman and Sachin RavikumarEditing by Kevin Liffey and Peter Graff)

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