The Bank of England governor, Mark Carney, was on Sky News at the weekend. He warned that the housing market in Britain was the biggest threat to the economic recovery.
Carney noted that the number of high loan-to-value mortgages (ie loans that require low deposits) was “creeping up”. He added: “we don’t want to build up another big debt overhang that is going to hurt individuals and is very much going to slow the economy in the medium term”.
All very responsible sounding. So what is he going to do about it?
The honest answer? As little as humanly possible.
Mark Carney washes his hands
If you’re worrying about a house price bubble, the natural reaction would be to raise interest rates.
After all, it’s rates that ultimately determine how much people can borrow, and therefore spend, on property.
But, as my colleague Bengt Saelensminde noted in his Right Side email the other day, the Bank of England has already said, last week, that it has no plans to raise interest rates any time soon. That’s despite Britain’s apparently rampant economic recovery. It also flew in the face of market expectations.
So what might the Bank do? Well, as Mark Carney said, it could – via the Financial Policy Committee – tell the government to rein in the Help to Buy scheme. Or it could insist on tighter mortgage lending criteria.
It might even do so at some point. However, said Carney, the basic problem with the UK housing market is that not enough houses are being built. There are “half as many people in Canada as in the UK, [but] twice as many houses are built in Canada every year than in the UK.”
In other words, at heart, Britain’s dysfunctional housing market isn’t about monetary policy, it’s about building more houses. And there’s not much the Bank can do about that.
Wait a minute – doesn’t Canada have a housing bubble too?
Everyone in the papers seems to have nodded sagely along with this Canadian statistic and let Carney get away with it without questioning it.
But hang on a minute.
Yes, it probably is a good idea to build more houses in Britain. We could also do with better and bigger houses, and a bit more imagination being applied to the property that we do build, and a lot more self-building, and all the rest of it.
But there’s a big problem with his line of argument.
He’s saying that Canada has half the population and is building twice as many homes as Britain each year. So all else being equal, he’s arguing that pressure on housing stock is very roughly four times as great in Britain as in Canada.
Trouble is, Canada also has a rampant house price bubble. In fact, according to the OECD think tank, Canada has one of the most expensive housing markets in the world – even more expensive than Britain or Australia.
So all that extra building isn’t helping them in the affordability stakes much.
What else do Britain and Canada have in common? Hmm, let’s see. Oh yes, Mark Carney used to be in charge of monetary policy over in that neck of the woods. And interest rates – while positively high by our standards, at 1% – are still incredibly low, and have been that way since 2010.
What really drives house prices
Here’s the reality: monetary policy drives house prices. It dictates the amount of money available to spend on property. It’s as simple as that. If all the Bank of England wanted to do was to cut house prices, then it could do so overnight by jacking up interest rates. It doesn’t need to build a single house to do that.
So all this talk of the housing market is a red herring. It’s only coming up at all because it’s the most obviously overheated part of Britain’s economy. So Carney can’t just pretend it’s not happening. But Mervyn King used to mutter about the housing market all the time. Did he do anything about it? Nope. And nor will Carney.
George Osborne put Carney in charge of the Bank of England because he thought he’d be a safe pair of hands who would deliver a growing economy by the time the election rolled around.
This isn’t a conspiracy theory. All I’m saying is that Osborne had to recruit a man for a job. He wanted that job done in a certain way, so he hired someone who would fit the bill.
A big part of the recovery is based on those rallying house prices. So while Carney might well tinker at the edges, he’s not going to do anything that pops the bubble. So interest rates aren’t going up on this side of the election.
On top of that, lots of companies are starting to wince as sterling gets stronger. If the market gets a whiff of rates rising, sterling could be off to the races and heading for $2 again (Dominic Frisby wrote about this the other day – his piece explains why the $1.70 mark is so critical). That would be painful for the exporters and manufacturers that we’re meant to be basing this recovery on.
What this means for investors
Carney is lucky in that inflation isn’t obviously a problem right now. For once, the annual growth rate of the consumer price index is below the Bank of England’s 2% target.
Of course, that may not last, and inflation is obviously a lagging indicator – once it’s rising at an uncomfortable rate, it’s often too late to stop it without doing something extreme. But for now, Carney at least has the excuse that inflation doesn’t justify higher rates.
What does it all mean? I suspect that sterling may have peaked versus the dollar for now. I suspect the US Federal Reserve will actually end quantitative easing this year, and that will come as a surprise to lots of people. Meanwhile, the market will gradually realise that – regardless of the strength of the UK data – Carney will resist raising rates with every breath between now and May 2015.
One way to profit would be to buy blue-chip stocks that have significant dollar earnings – such as drugs giant GlaxoSmithKline, the mining sector, or oil and gas stocks.
In the longer run, don’t expect the current lull in inflation to last. It’ll bounce back. And eventually the Bank will be forced to raise rates faster and higher than anyone expects.
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