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As the Bank acts on inflation so it will cool the housing market

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Published: 23 May 2022

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A rise in interest rates could cool the UK’s housing market, writes The Times Economics Editor David Smith.

Two things have happened recently, both in response to the surge in inflation to its highest since soon after Margaret Thatcher was elected with a mandate to bring it down. The first is that the Bank of England, celebrating 25 years of independence – if celebrating is not too strong a word – has been getting it in the neck. The second is that politicians have been jumping in with their own cost-of-living advice, telling voters how they can mitigate the effects of high inflation.

I’ll come on to the politicians in a moment. The Bank is under the cosh, not just because it is presiding over an inflation rate several times the official 2% target, to which it pleads that it is caused by factors outside its control. It is also being attacked for pumping up the housing market, in which inflation is already well into double figures, not least by the £450 billion of quantitative easing (QE) it has unleashed since March 2020, the start of the pandemic.

General inflation and house-price inflation are, of course, related. Some say that the Bank, in raising Bank Rate to 1% alongside a prediction that consumer price inflation will top 10% by the end of the year, is using a peashooter to try to stop a charging elephant. But there is method in the Bank’s approach. Not only does it think that most of this year’s inflation is caused by international factors and has been exacerbated by the war in Ukraine, but it also sees current high inflation as one of the factors that will bring it back down. Inflation, in other words, will be an instrument of its own demise.

Near-record lows in UK consumer confidence are not driven by fears of higher interest rates, but by the squeeze on real incomes that the Office for Budget Responsibility says will be the biggest since records began in the mid-1950s. That squeeze will reduce demand in the economy, probably more than could be achieved with any conceivable rise in interest rates, and weaker demand will bear down on inflation.

What is true of general inflation will also apply to the housing market. Consumer confidence surveys show that people do not think this is a good time for major purchases, and there is no bigger purchase than a new house. Not only that, but the Bank’s actions – both raising rates and beginning the process of “quantitative tightening” – reducing the size of its balance sheet – will slow the housing market and bring down house-price inflation, if not house prices.

Rising house prices, including an unexpected pandemic boom, have taken the house price-earnings ratio, a traditional measure of affordability, to new highs. According to the Nationwide Building Society, it stands at 6.8, compared with 5.9 at that start of the pandemic. In London the ratio is 10.8.

Another measure of affordability, also provided by the Nationwide, is first-time buyer mortgage payments as a percentage of take-home. This currently stands at 31.1%, slightly higher than the 27% to 29% range in the years leading up to the pandemic but not hugely so. In 2007, it stood at 46%. Low rates have worked wonders and compensated for rising prices.

That is now changing. Official interest rates have moved out of their post-crisis range and will go higher. The shift from QE to QT will push up long-term rates, important for the setting of fixed rate mortgages. Action to bring down inflation, which the Bank of England governor has likened to walking a fine line, will also cool the housing market

What about the government and the cost-of-living crisis? Ministers are bending over backwards to say that there will not be an emergency budget, though expectations are for a package sometime soon. The Queen’s Speech was notably lacking in new ideas, suggesting that a recent cabinet brainstorming session, which included suggestions such as that annual MOTs for cars could be extended to two years, have not yet got beyond the drawing board.

In the meantime, in a long tradition of unhelpful advice, ministers have been freelancing with their suggestions. George Eustice, the environment and rural affairs minister, suggested that households should buy supermarket own brands to reduce their bills. The government has suspended the outlawing of ‘buy one get one free’ offers in supermarkets, to help.

It is, as I say, a long tradition. Patrick Jenkin, a Tory minister during the miners’ strike of 1973-4, suggested that people should clean their teeth in the dark to conserve energy and, from memory, take a bath together. Eustice’s blunder was not realising that low-income families already buy from supermarket value ranges and that the campaigner Jack Monroe had recently pointed out that prices in these categories were rising faster than the average.

It may be possible for people to beat the average with canny shopping and treating supermarket special offers not as loss leaders to lure in the unsuspecting, but as a chance to save money. That said, people who are badly strapped for cash are fully aware of these tricks already. They do not need lessons from politicians.