MNI INTERVIEW2: UK House Prices Vulnerable - Ex-BOE MPC Miles

Decreasing real interest rates have been the key driver of a prolonged rise for UK house prices and this trend has continued following the Covid shock, Bank of England Economic Advisor and former Monetary Policy Committee member David Miles, said in an MNI interview, noting that the flipside is house prices are vulnerable if rates finally start to head higher.

While changes in property taxation have come and gone, Miles' research identified unanticipated changes in risk free real interest rates, reflected in index linked gilt prices, as the constant factor behind house price increases in recent decades. Post Covid, UK house price inflation has seen double digit rises with yield curves flattening and lenders squeezing margins.

"Over the past year the rise in house prices is partly because yields on government bonds, have moved down a little bit but I think it is also because - just in the last three or four months - the mortgage lenders, even in an environment of constant Bank Rate, have actually chipped a little bit off some of their mortgage rates and seem to be almost in a price war at the moment," Miles said.

There have been offers of 2, 3-year fixed rate mortgages of marginally sub-1 percent and "that is extraordinary," he said.

VULNERABILTY

That, however, does leave property owners vulnerable if rates start to head higher, with inflation in recent months rising and looking set to rise further above the Bank's 2.0 percent target as the Covid shock fades and supply shortages kick-in.

"If you get a winter of three, three and a half percent inflation numbers - maybe even a four in there - there is going to be, potentially, quite a change in message from the Bank of England and then the yield curve moves up. And then all those mortgage rates that are out there offering people two, three-year fixes at around one percent … could just be history," Miles said.

"There must be a significant chance something like that might happen. In that sense house prices are vulnerable; given the sensitivity to interest rate changes this is pretty much always the case"

REVERSAL

Nevertheless, it would take a reversal a four-decade trend lower in real interest rates to see UK house prices come under sustained pressure rather than tweaks to tax regimes.

"The main driver of the increase in house prices in excess of people's incomes in the UK … has been declining real interest rates. Medium term real interest rates, with a few wobbles up and down, have been on a declining path for almost 40 years," Miles said.

He also takes a nuanced view of the idea that with policy rates close to the effective lower bound and yield curves near flat the decline in interest rates that has driven house prices higher cannot be repeated.

"There is an argument that in the long-run it should be the real interest rate that matters for real house prices. While there is absolutely a natural lower limit on the nominal interest rate there isn't such a natural limit on the real interest rate," he said.

Despite 10-year index-linked UK government bonds currently trading at minus 2.5 percent real "You could go further down than that if you had a situation where people thought there would be a persistent overshoot of the inflation target and the central bank didn't raise interest rates to offset it."

FOR REGULATORS

Miles is clear that house price inflation concerns and the associated downside risks are a matter for the financial stability wing of the Bank and regulators, and not something that should be used to justify monetary policy changes.

House prices, as opposed to housing costs, are excluded from the UK's target inflation measure and as a result "you have got a tension if you have got one instrument, the interest rate, and you are trying simultaneously to do something on the house price front and consumer prices. You are often going to be pulled in two different directions."

"I don't think it makes sense to ask the central bank to control house prices. The more sensible thing for it to concentrate on is financial stability. That, of course, can be influenced by what happens in the housing market," he said.