Interest rates are set in the market place
The London housing market is booming. According to Nationwide, prices rose 14.9% over 2013. According to Halifax, they climbed 9.4%. According to the Land Registry they were up 11.2%. The Office for National Statistics hasn't quite got data for the whole year yet, but their numbers show prices up 11.6% in London in the 12 months to November 2013. No doubt Rightmove, LSL, Hometrack and all of the many other indices echo this finding. While we at the ASI have pointed out how the government has jacked up demand with the Help to Buy scheme (some have quipped it might more accurately be termed "Help to Sell") the Bank of England and Treasury have dialled down the housing element of the Funding for Lending Scheme in response to worries about a bubble and unaffordability.
But however much these schemes are artificially adding to demand, it is certainly clear that London houses—a desirable place for natives and people across the world to live—face a huge demand and are in limited supply. Since this is clear, I have been loath to call the situation a "bubble"—a bubble seems bound to pop, but tight supply and ample demand suggests a situation where prices will remain high (see an excellent post from my colleague Sam for more detail). However, it was recently pointed out to me that since a high fraction of UK mortgages track the Bank of England's base rate, a jump in rates, something we'd expect as soon as UK economic growth is back on track, could make mortgages much less affordable, clamping down on the demand for housing.
This didn't chime with my instincts—it would be extremely costly for lenders to vary mortgage rates with Bank Rate so exactly while giving few benefits to consumers—so I set out to check the Bank of England's data to see if it was in fact the case. What I found was illuminating: despite the prevalence of tracker mortgages the spread between the average rate on both new and existing mortgage loans and Bank Rate varies drastically. For example, it was almost one percentage point in January 2004, fell to 0.5pp by July, rose to around 0.6pp where it stayed until July 2006 when it crashed to nearly zero in a year, before rising to 1pp in October 2008 and then almost 3.5pp in April 2009. Since then it has steadily trended down to around 2.5pp. There are lots of interesting and obvious stories to tell here, hearkening back to my piece about the confusion between interest rates as a stance of monetary policy and interest rates as the actual cost of borrowing firms and consumers face, but what is clear is that tracker mortgages be damned, interest rates are set in the marketplace.
What this means is that the fact the Bank's base rate will almost certainly be hiked in the next couple of years if economic growth continues at its current healthy pace is not a reason to worry that London's housing bubble will pop. Indeed, the only way London house prices are likely to drop from their current stratospheric levels is if we get a good honest bit of planning deregulation. Moving the green belt out just one mile would allow us to build one million houses, after all. And it could add percentage points of pure supply-side driven growth to GDP and living standards.
