The Bank of England has no intention of pricking the housing bubble

Property for sale © Getty Images
Cheap money is driving house prices up

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.


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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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14 Responses

  1. 20/05/2014, Mark Otto Smith wrote

    There isn’t a house price bubble in much of the country, you need localised high demand plus enough debt available plus poor supply to produce a bubble. Outside London, good supply would pop most signs of a bubble.

    We could probably pack in luxury tower blocks to cover all non-family needs in London if we thought about how to squeeze them in. The infrastructure would need to be expanded to cope. If many are empty due to foreigners using them as investment properties then they help subsidise everyone else, money coming into the UK is obviously welcome with our trade deficit.
    To deal with family needs we need better transport in and out of London and loosening of planning- do we really need acres of rape seed fields to maintain the countryside? A bit more suburbia german style is possibly more environmentally friendly and a better human/wildlife balance that monocultures of this type.

    Obviously buy to let should only apply to new builds while house building is too low to keep pace with demand.

  2. 20/05/2014, Ellen12 wrote

    Its hard to see what the political intent is at the moment. The ‘Help to Buy’ concept may end up being very damaging politically if the second phase of it needs to be pared back or withdrawn. Even if, in itself, like Cameron suggests, does not directly contribute to unsustainable rises is house prices, it may have been a catalyst to get people speculating on house price rises.

    If there is a genuine house shortage, the question that needs to be asked is “Where are the people who need the housing currently living?” Some live with parents, some live with overcrowding and some are forced to move around a lot. But I suspect most people who want to buy a place of their own are renting in the private sector. I read in a newspaper a while back that one in ten people in the UK own a second property in the UK. If people didn’t invest in second homes/ houses, we would instantly increase the housing stock by 10%. It would free up availability and drive prices down and the tenants would be able to afford the house they are living in. But, of course, this exposes the banks again with all those BTL mortgages handed out under FLS.

    House building creates productivity and employment and is definitely more desirable for the economy then making existing housing scarcer and more expensive. But politicians appear afraid of the 60% of voters who own their homes and enable them to pretty much ‘live off’ the 40% who don’t. Also, most of the people who want to prevent Green Belt being built on own their homes and do not see their homes as a blot on the landscape.

    Interest rates, as a tool of monetary policy, can be a very blunt instrument. But maybe Mr Carney could look a refining it a bit and separate mortgage interest rates from the base rate. We want to encourage entrepreneurship in the economy and we are stuck with huge government debt so raising interest rates would damage the prospect for both. But raising mortgage rates should shake out investors from housing and thus allow FTBer and owner occupiers buy them up. Foreign investors should simply be taxed out of property, punitively.

    There does appear to be genuine alarm within the MPC and some of the cabinet about how dysfunctional the housing market has become and how damaged vast numbers of people in the UK are by the politicisation of, what should be, their homes. I hope you are wrong about Mark Carney and he makes the UK deal with its over reliance on growth via housing shortage and scarcity.

  3. 20/05/2014, Chester wrote

    Totally agree

    The consequences of stupid central banks meddling points to making them a redundant species – urgently

    No central banker publicly recognises their hand in bubble formation – once it blows, blame is always put on some external causality out of their control. All nonsense, and they know it

    It’s high time main street recognised that those charged with protecting the value of currency have failed miserably. They have demonstrated historic incompetence, deliberately stoked damaging inflation and protected debtors – all to the advantage of political allies at the expense of honest thrift

    If our idiot politicians actually wanted to redress so called wealth inequality, they would shut down central banks, restore honest price discovery, reward productivity and get out of the way

  4. 20/05/2014, Andrew M wrote

    Of course they won’t prick the bubble – not in an election year.

    They might just pull the trigger in a “scorched earth policy” if they see they aren’t likely to win the election. The actual mechanism would be cancelling help-to-buy and raising interest rates.

    • 20/05/2014, modsa wrote

      The BofE governor is of course non political, what he is doing is just for our good, how dare we think otherwise.

  5. 20/05/2014, Paul Claireaux wrote

    I think the Financial Conduct Authority has already pulled the trigger for reduced demand. There may be a slight delay in the tanker changing direction but turn it surely will. http://wp.me/p45vXF-hP

    • 24/05/2014, Inquisitor wrote

      Naughty FCA!

      They’re going to no doubt reprimand it if it does succeed at it, at least it shifts blame from the govt and its handmaiden bank to an “independent” (yeah, right) regulator.

  6. 20/05/2014, Pinkers Post wrote

    Thank you for this truly excellent analysis. An important and, for once, welcome contribution to this increasingly heated debate.  

    Bubble trouble! Not a day goes by without yet another scaremongering report on the UK housing bubble and the inevitable armageddon following the great burst. Society as we know it will be annihilated: It will, without doubt, be the end of civilisation.  Except, things never seem to work out the way we predict – terribly annoying! In fact, the markets hate nothing more than being told which direction they will take. May I take the liberty and quote Her Majesty: “Why did nobody see it coming?”, referring to the great crunch.

    As for the so-called London “property bubble”, it’s a myth. There never has been a bubble nor will there ever be one

    • 24/05/2014, Inquisitor wrote

      I still remember reading in 2006, when at uni, that “there was no housing bubble”. Come 2008, the collapse comes.

      I don’t think anyone is so stupid as to believe people who deny that there is a bubble. A few months ago, I remember reading mortgage and property industry spokesmen deny that there is a bubble, even whilst the Berenberg economist had pointed out there was a nascent property bubble. They have now changed their tune. So what is it that you know, that others don’t, that implies there is not a bubble? This is your opportunity to prove us all wrong. Perhaps, if you’re so inclined, even after its implosion comes, you can pretend there was no bubble by pretending to not know what the term means, like some RBC economists do. Digging one’s head in the sand is a time-honoured tactic.

  7. 20/05/2014, Merryn wrote

    The BOE might not have to do anything.. Lloyds is putting its own macroprudential policies into place in London. http://www.theguardian.com/business/2014/may/20/ms-profits-for-third-year-running-uk-inflation-cost-of-living-business-live?view=desktop#block-537b79dde4b0ecc738948d1a

  8. 20/05/2014, Alec wrote

    Everyone knows why Carney was hired simply to do the bidding for Cameron and Osborne. The house price bubble could be knocked on the head overnight by allowing the market to operate freely without the Government meddling and rigging interest rates. How many millions would be in negative equity if interest rates were normal, around 5% to 6% or even more? It would put an immediate stop to the nonsense and the property prices crash would once again make houses affordable for first time buyers. Of course all the speculators from the early 2002/3 onwards with the 130% interest only mortgages and the rest (drive by valuations, 10 times loan to value etc) would find themselves on the street but that would never do with an election in 11 months.

  9. 25/05/2014, CaptainPeacock wrote

    @moneyweek why was my post removed cos I replied to ‘Pinkers’ post in an inappropriate manner…?

    GOOD posts from both Inquisitor & Alec – WELL SAID!

  10. 23/06/2014, Dis Pair wrote

    Being newly subscribed and having read the comments and articles relating to the housing market, as one of those speculators, I would like to ask what are the experts forecasting over the next 10 years relating to house prices and interest rates? Should we sell now at a loss or later at a bigger loss, or hold on if prices are going to rise again?

  11. 22/10/2014, Knave Dave wrote

    As a writer on the U.S. economy who predicted the U.S. housing collapse six months before it happened, but (unlike the permabears) did not predict economic collapse for 2012 or 2013, I wonder if Britain is about to dump on the world what the U.S. did in 2008.

    I have not followed your housing market to see if you have the same pitfalls the U.S. did, but I suspect you do. The worst pitfall is adjustable rate mortgages. So long as the housing market escalates, everyone is safe. Someone who cannot pay his/her mortgage when the interest rate goes up, can sell the house for more than was paid. The home has appreciated during the five years between the introductory interest rate and the new higher rate. Or they can refinance for a permanent rate that about matches what they had because they have gained a lot of equity in their home. Everyone is fine.

    Enter a falling market, and you have no way out but foreclosure. The numerous people who cannot pay a higher interest rate when the rate rises, must sell their house for less than they owe. They cannot, so it forecloses. The banks can’t make money off the foreclosure either because the prices drop more before the house finally sells. Everyone suffers. Those foreclosures dumped on the market, in tern, pull the prices of everything else down more by competing against those prices with their own fire-sale prices. Within months, the nation enters a vortex where prices are cascading and more and more people cannot get out of their loans if they are unable to afford the higher adjusted rate.

    Even though adjustible rate mortgages were a recipe for disaster in the U.S., the U.S. (just like the Bank of England) learned nothing. It continued with adjustable rate mortgages and very low interest rates to entice people in BECAUSE the only way those in charge knew how to build up an economy was to build houses. They are incapable, it seems of thinking outside that box. So, to recover from the housing collapse, they did the worst thing possible. They perpetuated all of its sins. They took interest even lower than it had been to keep enticing people in; they paid off the debts with taxpayer money or with free money created out of thin air (economic easing). And they continued the adustable rate mortgages in order to keep enticing people in with even lower introductory rates than they had seen before. The now-wary home buyer was more reluctant buy, even still, so, in the U.S. the housing market didn’t recover much. In the U.K. where you didn’t feel that hit as directly as we did, you continued right back up that ladder of escalating housing prices. Now you have further to fall.

    The BofE and the Federal Reserve don’t want to pop those bubbles because the bubbles are the only game in town. All they have created in their “recovery” is bubbles. Stock market bubbles and renewed housing bubbles.

    –Knave Dave
    http://thegreatrecession.info

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