Tried house hunting in London? Gobsmacked by the soaring prices in estate agents’ windows? You are not alone. When even the agents – in my case a local surveyor – say the market feels like a bubble, you cannot help thinking it is time to back off.
That is what the Bank of England (BoE) is hoping we will all do – house buyers, lenders and estate agents alike. Britain’s property market, particularly London, is showing all the telltale danger signs of overheating: hence the action by the Bank’s Financial Policy Committee (FPC) to curb the number of high loan-to-income mortgages and require borrowers to be stress-tested against a sharp rise in interest rates.
Never mind that the UK’s Chancellor, George Osborne, triggered the latest price boom with schemes that brought down mortgage rates and cut the deposits needed on properties. At least he has now given Mark Carney, Governor of the BoE, the means to apply the brakes. And the FPC’s steps are long overdue.
Britain’s real-estate bubble is far from unique. A report by Beat Siegenthaler, a UBS strategist, shows the UK is just one of several big, developed economies where house price-to-income ratios have risen well above their historical averages: Canada, Australia and New Zealand have higher ratios.
“Policy-makers around the world are struggling with potential asset bubbles,” says Siegenthaler. “The most dangerous of bubbles are deemed to be those in housing markets, as their bursting could wreck whole economies.”
"An increase in interest rates, if too steep, would risk choking off economic recovery"
New Zealand, for its part, began tackling its housing bubble last year. The country’s central bank was among the first to warn of house price inflation – a natural consequence of cuts in interest rates to historical lows at the height of the financial crisis – and introduced loan-to-income ratios in October 2013.
Siegenthaler points to mixed results. Annual house-price inflation is still running at over 10%. The central bank started raising interest rates – a blunter tool – in March.
The problem for the BoE in following New Zealand’s lead is that an increase in interest rates, if too steep, would risk choking off economic recovery. Besides, a boom in house prices, unless it looked like stoking wider inflation, would not demand a rate hike under a monetary policy regime that excludes housing costs from targeted inflation.
That is a pity. A measured rise in interest rates would certainly seem a more straightforward response, regardless of debate over the merits of different inflation measures.
Effective measures?How effective, then, will the FPC’s measures be? So far, its action appears designed to signal preparedness. A limit has been set to restrict lending at multiples of 4.5 times income to no more than 15% of a bank’s new lending for residential home purchases. In fact, no bank at present exceeds this limit and the average level of lending above a 4.5 loan-to-income ratio is only 10%, so it is not binding on any lending.
The Bank has also said lenders must ensure new borrowers will still be able to afford their loans if interest rates rise 3% in the first five years of a mortgage loan. But the BoE has also admitted that this limit is very similar to banks’ existing practices.
Tellingly, on the day these rules were imposed, shares in UK housebuilders jumped sharply. Stock market investors took the view that the effects would be minimal.
Cash buyersAmong the least affected, of course, are cash buyers. And it is an influx of cash-rich foreign buyers at the top end of the London property market that has contributed in part to more rapid price gains in the capital. By contrast, more first-time buyers may, over time, find themselves priced out, as they are the ones who stretch to get on the housing ladder. If these borrowers scramble to buy before the FPC’s limits kick in, there could even be a short-term jump in prices.
There are signs that the housing market has started to cool, with UK house prices growing at their slowest rate in over a year from June to July. But month-on-month price changes are volatile. My guess is a growing economy and falling unemployment will probably keep the annual rate of inflation between 7% and 10% over the coming months – and the boom in London will spread elsewhere.