A monetary revolution that will stoke house prices


Yesterday, everyone from policy makers to pensioners, researchers to investors had their eyes on the new Bank of England governor, Mark Carney. In a bold and audacious move – something you couldn’t have told by his delivery – Carney broke from the orthodoxy and decided to effectively peg interest rates to unemployment. But why does this matter and what effect will it have on housing?

Let’s get the basics out of the way first. The Bank of England sets the short term base rate which is the rate of interest at which it lends to or borrows from private banks. The idea is that the Bank of England will change this rate accordingly in order to ensure inflation is kept relatively low (to preserve its value).

Currently, this rate is at an historic low at 0.5% as a result of the financial crash and subsequent economic difficulties. The theory goes that low interest rates makes borrowing cheaper and saving less worthwhile and so incentivises people to spend and businesses invest. The downside to this approach is that an increase in spending and transactions within an economy will speed it up and will create inflation. The difficulty, therefore, is finding the balance between stimulating the economy through cheap lending and preserving the value of people’s savings and pensions.

Carney’s big shift is to introduce the Bank’s ‘forward guidance’ system. Under this mechanism, Carney has said that the base rate will only change once unemployment falls to 7% – currently it is at 7.8% – meaning an extra 750,000 new jobs will be required and so links economic performance (and not just inflation) to the base rate. In theory, this gives lenders and borrowers more stability as they know that the base rate won’t be changed until unemployment hits its target, estimated to happen in 2016. The difficulty, however, is ensuring inflation does not get out of hand (although it should be noted that nominal wage increases have been low and relatively stagnant).

So what does this mean for people?

Well, as with any policy, there are winners and losers. The winners are those with mortgages, as they have confidence that the rate (theoretically) will remain unchanged, potential borrowers, who can borrow cheaply and lenders, who will have confidence that the cost of borrowing from the Bank of England will remain the same. The initial losers will be those with savings and pensions as the value of these is decreasing due to inflation.

Will this impact on the housing market?

The indirect effect of this new monetary policy is that when credit is cheap – especially over a long period of time – banks will have more confidence in the immediate outlook and may decide that they can lend more. This will mean the availability of credit increases and potentially more mortgages are issued.

When we combine this with the Government’s Help to Buy scheme – which will increase the demand for mortgages but not the supply of housing – the new monetary policy will stoke the already large house price fire.

Without a corresponding large investment into housing to increase the numbers of homes and affordable homes, this will act as just another policy pushing up house prices.

Twitter: @joesarling



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