BoE warns that housing bubble risks derailing economy
The Bank of England has given its strongest warning yet that a housing bubble threatens to derail the UK economy, saying that spiralling property prices were “the very brightest [hazard] light” on its dashboard.
In a speech in London on Thursday evening, Sir Jon Cunliffe, deputy governor, said the danger signs resembled “a movie that has been seen more than once in the UK”.
His speech came after figures from the Nationwide Building Society showed house prices rose at a double-digit 10.9 per cent annual rate in April, sending the pound to a five-year high against the US dollar and intensifying expectations of earlier interest rate rises.
Sir Jon has kept his views on the economy and the housing market private since joining the BoE last November, but as the head of financial stability he has an influential role in the bank’s policy making.
Noting that house building was still lagging far behind demand for property, he said, “there is good reason to believe that a mutually reinforcing combination of strong demand, weak supply and expectations of a rising market could lead to a period of sustained and very powerful pressure on house prices in the UK”.
Making clear that this time the BoE would not stand by as prices rose, he added, “it would be dangerous to ignore the momentum that has built up in the UK housing market since the spring of last year”.
The June meeting of the Financial Policy Committee, on which Sir Jon sits, will mark a test of the UK’s unproven new framework, which aims to use financial regulation to curb booms and busts.
The FPC has a range of levers it can pull to calm the market down. It can recommend a tightening of underwriting standards in the mortgage lending market, which is already subject to a new regulatory regime aimed at ensuring borrowers can afford to pay off their loans.
Alternatively, it could recommend that the Treasury pares back the generosity of its Help to Buy scheme, which guarantees mortgages to homebuyers with small deposits.
The Committee can also force banks to hold more capital against their mortgage lending, in the hope that this will make them more resilient if there is a subsequent property downturn.
A more extreme measure would be to recommend that a cap is imposed on the ratio of mortgages relative to a home’s value or an individual’s income.
This, however, is seen as politically charged turf in the BoE, and it has previously shied away from demanding formal legal powers to impose these ceilings.
Sir Jon also made it clear that households must accept that interest rates will need to rise “once the recovery is well established”, a condition that has arguably already been met.
“It is particularly important at present to ensure that the current low levels of interest rates do not mask the likely cost of mortgages and so create more headroom for prices to rise,” he said.
Expectations of earlier interest rate rises intensified in the City even before Sir Jon’s speech after strong economic data underscored the pace of the recovery and investors viewed the UK as the destination for their money.
Market expectations now predict the first British rate rise in February or March next year, significantly earlier than the consensus of May that was priced in three months ago.
The British government now also has to pay considerably more to borrow in sterling than many eurozone economies. The difference between government borrowing costs for the UK and Germany have reached a level not seen since the eurozone was created.
“The market is starting to directly challenge the Bank of England’s forward guidance policy,” said Steven Major, global head of fixed income research at HSBC. “Stronger data on average earnings, unemployment and manufacturing activity have resulted in consensus opinion among investors that the Bank of England will put interest rates up next year.”
The strong economy and expectations of higher interest rates has fuelled financial flows into Britain, pushing up the exchange rate.
The pound has climbed around 10 per cent on a trade-weighted basis and 11 per cent against the dollar since last July – the strongest performance among major developed country currencies over that period – although it remains well below the peaks reached before the financial crisis.
Its recent bounce is also in part a function of growing uncertainty about the speed of the US recovery – with the UK’s first-quarter growth spurt in stark contrast with the sputtering performance of the US. Neil Mellor, currency strategist at BNY Mellon, said the pound could “catapult higher” if it broke through a level of 1.70 to the dollar.
The strength of the recovery and market reaction challenges the mood music from the Bank of England, which has remained dovish. Members of the Monetary Policy Committee have stressed the lack of urgency to raise interest rates, that any move upward would be gradual and that rates are unlikely to move back to normal levels of around 5 per cent.
The BoE will produce new forecasts this month and will formally adopt new guidance, linking interest rates to “slack” in the economy, which it is likely to see as falling alongside lower unemployment and underemployment.
“They need to hike rates and they need the pound to go up to prevent the housing market going into a bubble”, said James Kwok, head of currency at Amundi Asset Management, who thinks Asian property investors still see sterling as cheap compared with 2007 levels when they buy in London.