Edmond Warner: Sir Eddie must slay the housing market beast
Put away the peashooters. This is a job for a bigger weapon. The Bank of England's armoury is a curious place. In one corner sits a mighty cannon, coated in a thick layer of dust.
Put away the peashooters. This is a job for a bigger weapon.
The Bank of England's armoury is a curious place. In one corner sits a mighty cannon, coated in a thick layer of dust. Racked upon a wall are peashooters of various shapes and sizes. Otherwise it is empty. Which makes it rather difficult for the Bank to win the odd skirmish in a civilised fashion. After all, sometimes it pays not to obliterate one's opponent.
This week the Bank's governor, Sir Eddie George, his two deputies and other members of its monetary policy committee trotted over to the House of Commons to account for their conduct of monetary policy. Just to be on the safe side - some of these young Liberal MPs can be rather uppity, you know - they each tucked a peashooter into their breast pocket.
They came in jolly handy, too. As the week drew to a close the markets resounded to the rat-a-tat-tat of the Bank's hardest of split peas bouncing off the chest plate of the warrior that is the nation's housing market.
"Now look here, naughty fellow. We've got this rather hefty cannon back at the ranch. If you don't calm down right now, we might just have to fire off an interest rate rise or three in your direction. So just think on it, alright?" Or words to that effect.
One has to sympathise with the Bank. House prices in May inflated at an even faster rate than at the height of the late 1980s boom. Consumer spending is expanding as a direct consequence. The money has got to come from somewhere, and that somewhere is the finance industry. All of which increases the extent of the damage that any subsequent bust would inflict. And the Bank knows that, by raising rates, it might just trigger that bust.
So, out with the peashooters. But why should any single homeowner or prospective homeowner listen? When house prices are on the rise it is easy to assume that their "inexorable" increase will rescue you from any financial misfortunes. Might lose your job? Don't worry, you'll always be able to pay down your mortgage (four times the salary that has just been terminated) by flogging your property at a profit.
A look ahead
At least Sir Eddie succeeded in getting the MPC's concerns onto the front pages of the press. Now, though, he probably has to raise the cost of borrowing if only to ensure that any future rhetoric is taken seriously. The money markets indicate that investors expect the 4% base rate to reach 4.75% by the end of the year, with the first rise coming next month.
There are two ways of viewing an increase of such magnitude. Either it is a hefty 19% increase in the cost of money and should thus draw borrowers up short. Or it is insufficient to restore what economists would calculate to be a neutral interest rate, and therefore unlikely to dull the attraction of estate agents' windows.
The MPC's deliberations must be especially difficult now, for the UK's overheating housing market is a peculiar local difficulty. In the US there is little reason to contemplate an increase in interest rates that, at 1.75%, are less than half those over here. And just like in America, our overall economy remains anaemic.
The rise in property prices has demographic foundations, but the boom is a financial phenomenon. The combination of low interest rates and poor returns from alternative assets has encouraged the buy-to-let market, adding a whole new lump of demand on to one end of the seesaw, catapulting prices higher.
The risks
Now, the financial rationale underpinning many buy-to-let investments has become very thin, prices having adjusted upwards to remove the "easy" gains available when the trend had yet to become a fad. Factor in a realistic risk of rental hiatuses and repair and maintenance costs and the cashflow attractions disappear altogether - particularly for those borrowing to buy - leaving only the hope of continued capital gains.
It is possible, given current conditions, that the slightest touch on the interest rate tiller will turn the buy-to-let tide, releasing stock into the housing market from distressed sellers. History, though, is not on the Bank's side. Property prices are slow to react to conditions in the economy and to interest rate changes, but when they eventually do, they do so dramatically.
Government can intervene in the housing market, but its instruments too are blunt. Many will regard stamp duty, for example, as merely a cost of being in the game, not a reason to play elsewhere. Similarly, levying full council tax on second homes is unlikely to deter those capable of affording them in the first place.
The best answer might be taxation targeted at the residential property investment market - a supertax on rental income, perhaps. This government is unlikely to have the stomach for the attendant electoral risks, though. Time, then, to dust down the big gun.
· Edmond Warner is chief executive of Old Mutual Financial Services.
The Bank of England's armoury is a curious place. In one corner sits a mighty cannon, coated in a thick layer of dust. Racked upon a wall are peashooters of various shapes and sizes. Otherwise it is empty. Which makes it rather difficult for the Bank to win the odd skirmish in a civilised fashion. After all, sometimes it pays not to obliterate one's opponent.
This week the Bank's governor, Sir Eddie George, his two deputies and other members of its monetary policy committee trotted over to the House of Commons to account for their conduct of monetary policy. Just to be on the safe side - some of these young Liberal MPs can be rather uppity, you know - they each tucked a peashooter into their breast pocket.
They came in jolly handy, too. As the week drew to a close the markets resounded to the rat-a-tat-tat of the Bank's hardest of split peas bouncing off the chest plate of the warrior that is the nation's housing market.
"Now look here, naughty fellow. We've got this rather hefty cannon back at the ranch. If you don't calm down right now, we might just have to fire off an interest rate rise or three in your direction. So just think on it, alright?" Or words to that effect.
One has to sympathise with the Bank. House prices in May inflated at an even faster rate than at the height of the late 1980s boom. Consumer spending is expanding as a direct consequence. The money has got to come from somewhere, and that somewhere is the finance industry. All of which increases the extent of the damage that any subsequent bust would inflict. And the Bank knows that, by raising rates, it might just trigger that bust.
So, out with the peashooters. But why should any single homeowner or prospective homeowner listen? When house prices are on the rise it is easy to assume that their "inexorable" increase will rescue you from any financial misfortunes. Might lose your job? Don't worry, you'll always be able to pay down your mortgage (four times the salary that has just been terminated) by flogging your property at a profit.
A look ahead
At least Sir Eddie succeeded in getting the MPC's concerns onto the front pages of the press. Now, though, he probably has to raise the cost of borrowing if only to ensure that any future rhetoric is taken seriously. The money markets indicate that investors expect the 4% base rate to reach 4.75% by the end of the year, with the first rise coming next month.
There are two ways of viewing an increase of such magnitude. Either it is a hefty 19% increase in the cost of money and should thus draw borrowers up short. Or it is insufficient to restore what economists would calculate to be a neutral interest rate, and therefore unlikely to dull the attraction of estate agents' windows.
The MPC's deliberations must be especially difficult now, for the UK's overheating housing market is a peculiar local difficulty. In the US there is little reason to contemplate an increase in interest rates that, at 1.75%, are less than half those over here. And just like in America, our overall economy remains anaemic.
The rise in property prices has demographic foundations, but the boom is a financial phenomenon. The combination of low interest rates and poor returns from alternative assets has encouraged the buy-to-let market, adding a whole new lump of demand on to one end of the seesaw, catapulting prices higher.
The risks
Now, the financial rationale underpinning many buy-to-let investments has become very thin, prices having adjusted upwards to remove the "easy" gains available when the trend had yet to become a fad. Factor in a realistic risk of rental hiatuses and repair and maintenance costs and the cashflow attractions disappear altogether - particularly for those borrowing to buy - leaving only the hope of continued capital gains.
It is possible, given current conditions, that the slightest touch on the interest rate tiller will turn the buy-to-let tide, releasing stock into the housing market from distressed sellers. History, though, is not on the Bank's side. Property prices are slow to react to conditions in the economy and to interest rate changes, but when they eventually do, they do so dramatically.
Government can intervene in the housing market, but its instruments too are blunt. Many will regard stamp duty, for example, as merely a cost of being in the game, not a reason to play elsewhere. Similarly, levying full council tax on second homes is unlikely to deter those capable of affording them in the first place.
The best answer might be taxation targeted at the residential property investment market - a supertax on rental income, perhaps. This government is unlikely to have the stomach for the attendant electoral risks, though. Time, then, to dust down the big gun.
· Edmond Warner is chief executive of Old Mutual Financial Services.
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