At the time of writing the Monetary Policy Committee of the Bank of England is busy deliberating as to whether to raise the base lending rate (currently at 4.5%). The consensus view is that the rate will go up a quarter point. Others speculate on a half percent rise (the National Institute of Economic and Social Research – NIESR – is even advocating this). Of course there is always the possibility that the rate will remain unchanged.
Whatever the speculation about the final decision, there is little mistaking the key factor in the decision: the Uk housing market. The centre of debate is really whether the UK housing market has peaked, or whether more rate raising is needed to bring the market back into line with reality. This is a classic bubble bursting situation.
On this topic the NIESR has no doubt: last week they indicated that on their view house prices needed to fall by about 30 per cent to return to their true value. To bring house prices back to their equilibrium level they advocated one remedy: let the housing market crash.
The FT quotes Ray Barrell, senior research fellow at the institute, as saying ?The Bank is worried about putting up interest rates too hastily because of the effect on the housing market and consumer demand. But if you have a boil it’s better to lance it earlier rather than later.?
So the boil may be lanced. But maybe it already has been. This is the difficult question. Rate changes are notoriously ‘lagged’ in their impact on real economic activity. So today’s decision will not be an easy one.
But whatever it is, one thing seems clear: one day or another the UK housing market will crash. Even if the NIESR are right about the 30% overvaluation, there is no guarantee that any crash will be limited to a 30% fall in values, there will probably be the problem of ‘overshoot’ before the market finds its level.
And what will be the impact of such a crash on the UK economy? Only time will show.
One little commented aspect of this situation is the comparison between the EU’s two ‘housing bubble’ economies: the UK and Spain. One is in the eurozone, the other isn’t. One has the ability to set its own rates, the other doesn’t. The UK rate is already 2.25% above the ECB one. Spain still has the 2% eurozone rate set by the ECB (which isn’t expected to change today). Yet Spain has a housing boom every bit as dangerous as the UK one, yet they are virtually powerless to deo anything about it. Which will end better (or worse, if you prefer it that way)?
Will there be lessons here for the single currency question when the cost of the broken plates is counted up. I suspect there will be. But then, as ever, the future is an open question.