European RMBS: Basis Risk in a Rising Rate Environment

The Bank of England (BoE) today announced the largest rate rise in over 25 years at 0.50%. The BoE has raised its base rate six times to 1.75% at present from 0.10% in December 2021, and further rate hikes from the European Central Bank and the BoE are not a forgone conclusion. In this commentary, we explore the basis risk in European RMBS transactions, the key mitigants, and why, in our view, basis risk is more pronounced in a rising rate environment.

“A combination of lag in updating the interest rate on mortgages relative to RMBS bonds could lead to RMBS transactions exposed to basis risk stress in a rising interest rate environment,” said Ketan Thaker, Head of European RMBS and Covered Bonds at DBRS Morningstar.