Mark Carney’s importation of the forward guidance approach has been all over the mainstream and social media. But how significant is the announcement that the Bank of England is planning on keeping nominal interest rates as they are until after the next General Election? The comment it has attracted has covered the spectrum: positive, negative, and a bit meh. Commentators have picked up on a number of more specific issues, such as Frances Coppola’s post yesterday on the prospects for savers and Jules Birch rightly pointing out that the commitment to keeping interest rates low, combined with the Government’s Funding for Lending scheme, is going to give the revival of Buy to Let further momentum.
It is the housing dimension that, you might be surprised to discover, I wanted to comment on further.
Carney’s intervention comes shortly after several other housing–related snippets of news.
We’ve seen Fitch join the ever-growing ranks of critics of the Government’s Help to Buy policy. Help to Buy must be one of the loneliest policies there has ever been. Apart from the Quad at the heart of Government and the builders and lenders who stand to benefit from it directly, no one with any understanding of the housing market thinks it has any merits. Even Vince Cable has tried to distance himself publicly from it. He’s smart enough to see that it is almost certain to end badly.
We’ve had news of strong house price growth in the second quarter of 2013, which – as always – has rather bizarrely been constructed as indicating the housing market is on the mend, rather than chronically sick. Not unrelatedly, the “We’d rather not pay Tax” Payers Alliance has been all over the media pointing out that most of the stamp duty that gets paid is paid by those in London and the South East, and that this is a tax on aspiration that needs to go.
What are we to make of these fragments?
One peculiar aspect of this discussion is that the increase in house prices is being spun by its advocates as a vindication of the Government’s approach to supporting lending. It’s helping to “get the housing market moving”. But it hardly follows that this rebuts criticism. The policy’s critics would hardly disagree. The main concern was that the policy risks inflating a bubble because, even if supply responses sufficiently – which is highly doubtful – the price effect is going to be much more immediate. We know that new construction is picking up a bit. But it is doing so from a low base and not at sufficient scale to diffuse the bubble-building momentum.
To be honest, the news that house prices are already growing strongly ought to be taken as an even stronger warning signal. If anything it suggests that, even in its own terms, the second part of Help to Buy, that hasn’t been implemented yet, isn’t needed. If the Government goes ahead with it in January 2014 then it is doing no more than pouring paraffin on a barbeque that is already sizzling dangerously hot.
However, we also need to recognise that focusing on national house prices averages does not really tell us the story of what is happening on the ground. More disaggregated figures show that London and the South East are largely responsible for house price growth and prices in the rest of the country are reasonably flat. The figure below illustrates the point clearly.
This takes me back to Mr Carney and his interest rate policy. Some of the reaction to his announcement should have been read as a stark warning of problems ahead and a damning indictment of our housing policy over many years. News bulletins featured any number of households earning good salaries who welcomed Mr Carney’s policy stance. They expressed relief that interest rates were going to stay where they are because they were mortgaged up to the hilt and felt they would face significant affordability problems if interest rates increased.
That is, if base rates increased from a pretty much unprecedented nominal rate of 0.5%. As they surely will eventually. You don’t have to have great insight to forecast that as and when interest rates return to something like normal – maybe 5% – there is going to be absolute carnage in parts of the housing market, predominantly in the South East.
Having got into this position, it is worth reflecting on how to get out of it. Deflating house prices won’t necessarily be welcomed. You risk having a significant group of households who are not only servicing an unaffordable mortgage but also carrying negative equity. And that is a risk that Help to Buy will increase. Make no mistake, this is an utter mess.
Those who have been thinking about housing markets for a long time – let’s say pre-2007 – will know that in the past we have had debates over interest rate policy and the problems caused by the divergence between the housing market and the real economy. Back in the day it was clear that the housing market was overheating, which would have pointed to increasing interest rates, whereas the rest of the economy wasn’t necessarily in the greatest of health, which pointed to keeping interest rates low. This is pretty much an irreconcilable tension if you only have, or are only willing to use, one policy instrument.
Mr Carney’s forward guidance approach to interest rates suggests that the needs of the broader economy are being prioritized over those of housing market stability, accepting for the sake of argument the debatable premise that ultra-loose monetary policy actually has a positive impact on the real economy. The upward push to house prices is only going to be reinforced. Something that would be exacerbated if the “We’d rather not pay Tax” Payers Alliance were to get its way. Yet, given the regional divergence in house price trajectories it isn’t obvious that the housing market is sending a clear interest rate signal anyway at the moment. Should rates be going up to calm overheating or stay as they are because activity is pretty flat? Manipulating a single national interest rate is too blunt an instrument to address the issue.
The most intriguing part of Mr Carney’s announcement is, therefore, one of the elements that has received less attention. He laid down conditions under which the BoE might act contrary to the forward guidance it has given. One of the conditions was if the zero-rate policy threatened financial stability in ways that cannot be managed using firmer application of the Bank’s regulatory and supervisory powers.
What is interesting about this statement is that idea that the Bank is going to try to ensure fiscal stability through firmer application of its powers. Through its Financial Policy Committee it has powers to rein in mortgage lending if the housing market looks like it is getting out of hand. As I have argued before, the form of those powers is weaker than would be desirable because the FPC would appear to have succumbed to political pressure not to control the parameters of mortgage lending very directly. Perhaps Mr Carney is made of sterner stuff.
It strikes me that this could – or perhaps should – be where the action is going to be if the BoE is going to be able to do anything to curb the excesses of the housing market. As far as I’m concerned, that would represent a far more significant change of policy stance than announcing that interest rates aren’t going to change for a couple of years, when it was pretty obvious they weren’t going to change anyway.
Image: World Economic Forum via flickr.com under Creative Commons.