When will the buy-to-let bubble burst?

The minutes from the MPC's August rate setting meeting suggest further interest rate hikes in the future. And that's bad news for any buy-to-let landlords who jumped on the bandwagon in the last year. So how long before the market dries up?

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Minutes from the Bank of England's August interest-rate setting meeting revealed nothing that we didn't already know.

Gordon Brown's new man on the Monetary Policy Committee, David Blanchflower, is - surprise, surprise - a dove. He was the only one of the seven-strong committee (it's two members down at the moment) to vote against a rate hike. Mind you, you can't expect a great deal of sense from a man whose crowning academic glory is a piece of research that proved that having more sex tends to make people happier.

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Doubtless the two new MPC members who join in October - both Treasury appointees - will also be doves. But with six members actually worrying about inflation, that still leaves the odds stacked in favour of a rate hike.

And that's bad news for all those new buy-to-let landlords who have jumped on the bandwagon since the start of this year

The buy-to-let property boom continues unabated. According to the Council of Mortgage Lenders, landlords took out 152,500 mortgages in the first six months of 2006, up 56% on the same time last year, and setting a new record.

Let's see - a record number of people are piling into the market, just as house prices are at their highest levels ever. Some people - people like us here at MoneyWeek, for example - might suggest that this is a sure sign of a bubble in the market.

But plenty of others would dismiss us as killjoys. Kelvin Davidson at Capital Economics commented on the figures, saying "Lending criteria remain relatively stringent, suggesting that the boom has a stable footing."

Just as Kelvin's comments arrived in the MoneyWeek inbox, we also heard from Abbey. The high street bank excitedly yelped that it was extending its lending criteria on buy-to-lets. "Abbey will now lend up to £1 million per property at 85% loan-to-valueAbbey also has a low minimum rental cover, requiring the minimum rental income to be 120% of the mortgage payments."

Apparently this "makes buy-to-let more feasible for all types of landlords." Especially ones who don't know what they're doing and are desperate to get on the buy-to-let property bandwagon - even if it means borrowing too much and effectively paying their tenants to live in their home.

Here's what happens every time there's a bubble. The bubble starts for good reasons - houses are too cheap, so smart investors buy them. House prices soar, the smart investors get rich, and other people dive in. Eventually everyone and their mother-in-law want to buy a house. People start saying things like "You can't go wrong with bricks and mortar" or "house prices can't go down - the Government won't allow it."

The banks who lend money to these people record better profits than ones which are more careful. Shareholders start asking why their bank isn't making as much profit as the others. So banks have an incentive to chase more lending business, leading to a "race to the bottom" to see who can attract the least-creditworthy customers.

It's not as if we haven't seen this before. In fact the last time was just a couple of years ago. All the bad debts currently being reported by the banks were a result of a similar rush to grab as much unsecured lending business as possible during 2003 and 2004, when interest rates were down below 4%. The banks - not to mention all the press pundits who were strangely quiet about it at the time - now realise they loaned too much to people who couldn't or wouldn't pay it back.

But have they learned? Of course not - people never learn. Now they're doing the exact same with secured lending - and all the pundits are once again arguing that it's sustainable.

The bigger the boom, the bigger the bust. The property pundits will of course try to draw out the boom for as long as they can. In fact, we wouldn't be at all surprised if a wave of more negative reports on house prices start to appear, now that the Bank of England has hiked interest rates. Phrases like - "a vulnerable market" and "further interest rate hikes are unnecessary" - are likely to crop up in this month's wave of property propoganda.

We think it's more than a tad delusional for estate agents and property companies to imagine that their poorly constructed little surveys have a real influence on interest rate policy in the UK - but it won't stop them trying.

But ultimately, the buy-to-let property bubble is all about rocketing debt, not gains in the intrinsic value of housing. Interest rates are now rising, and when lenders finally realise that they've made the same mistake with secured lending that they did with unsecured, the excitable press releases will dry up and so will the market.

That's when the whole thing tumbles into reverse, people desperately try to bail out, and prices go into a long slow slump. Until one day, property becomes cheap again, and smart investors will start looking at the market. That's when MoneyWeek will be suggesting that you buy into UK property - but that day's a long way off yet.

Turning to the stock markets

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The FTSE 100 finished flat on Wednesday, down just one point at 5,896. The blue-chip index recovered from the morning's losses - which saw it head as low as 5,848 - when a strong start on Wall Street, prompted by more good news on inflation, improved sentiment in London. China's assurances that it is not facing an economic slowdown boosted the mining sector: Vedanta, BHP Billiton and Rio Tinto were among the day's top performers. Despite reporting a sharp rise in profits, British Energy was the biggest faller of the day as weaker output figures and caution over the power generator's ability to hit output targets prompted profit-taking. For a full market report, see: London market close

On the continent, the benign US inflation data pushed European stocks higher. The Paris Cac-40 ended the day up 22 points at 5,137, with technology stocks such as Capgemini and STMicroelectronics leading the way. And the German Dax-30 rose 36 points to 5,812.

Across the Atlantic, US stocks ended higher for the third day straight following the release of consumer price data which further allayed inflation fears and suggested that the Fed would keep rates on hold for the time being. The Dow Jones and S&P 500 reached their highest levels since mid-May, closing up 98 points at 11,327 and up 9 points to 1,295 respectively. The Nasdaq was also 34 points higher, ending the day at 2,149. And strong sales of printers and PCs saw technology firm Hewlett-Packard's profits soar to $1.38bn in the third quarter, boosting the share price by 5% in after-hours trading.

Enthusiasm over weak US inflation data, along with the falling oil price, initially boosted Asian stocks, but petered out later. The Nikkei 225 ended the day 50 points lower at 16,502. The Hang Seng also slipped lower after strong early trading, down 78 points to 17,372 in afternoon trading. Investors are currently awaiting telecoms giant China Mobile's first-half results.

The oil price continues to fall, almost reaching a two-month low, as signs of slowing US growth and the end of the driving season ease demand. Crude was trading at $71.42 a barrel in New York this morning, whilst Brent spot was at $72.03 in London.

Spot gold gained $3 an ounce late on Wednesday to reach $629.40 as the weaker-than-expected inflation data hit the dollar. Silver was also up to $12.25 an ounce in New York late last night.

In London this morning, BA has announced that it has no plans to sue the British government over delays caused by last week's terror alert. Ryanair had approached BA, Virgin Atlantic and others in order to persuade them to claim compensation under the British Transport Act, airlines alleged. And retail sales figures for July are due this morning. Surveys of economists conducted by both Bloomberg and Reuters suggest that they will reveal a sixth consecutive rise due to the positive effect of the World Cup and hot weather on food and drink sales.

And our two recommended articles for today...

Prepare for Peak Oil, says energy expert

- We can no longer live in denial, says Iranian energy expert Ali Samsam Bakhtari - the world is at Peak Oil. The price of crude could soon break through the $100 mark as conventional oil production begins to decline. So what should we do? Can manufactured fuels and alternative energy sources meet our needs? Find out what the rules of post-Peak Oil world will be - and why Bakhtari thinks we need to start making changes now - by reading: Prepare for Peak Oil, says energy expert

Why higher interest rates are a necessary evil

- The Bank of England's decision to raise rates this month came as a nasty shock to markets. Estate agents and business lobbyists may be complaining, but it was about time the supply of cheap credit that's led Britain into a debt nightmare was cut off. To find out why rates may need to rise even further, read: Why higher interest rates are a necessary evil

John Stepek

John is the executive editor of MoneyWeek and writes our daily investment email, Money Morning. John graduated from Strathclyde University with a degree in psychology in 1996 and has always been fascinated by the gap between the way the market works in theory and the way it works in practice, and by how our deep-rooted instincts work against our best interests as investors.

He started out in journalism by writing articles about the specific business challenges facing family firms. In 2003, he took a job on the finance desk of Teletext, where he spent two years covering the markets and breaking financial news. John joined MoneyWeek in 2005.

His work has been published in Families in Business, Shares magazine, Spear's Magazine, The Sunday Times, and The Spectator among others. He has also appeared as an expert commentator on BBC Radio 4's Today programme, BBC Radio Scotland, Newsnight, Daily Politics and Bloomberg. His first book, on contrarian investing, The Sceptical Investor, was released in March 2019. You can follow John on Twitter at @john_stepek.