Tuesday, July 01, 2003
Housing blocks the road to the euro
Posted by David Smith at 03:51 PM
Category: David Smith' s magazine articles

The dust has settled on Gordon Brown’s June 9 “not yet” assessment of Britain’s readiness for euro entry but the questions remain. Can the chancellor possibly conclude by the time of his budget in March or April next year that enough has changed to justify another assessment?

The suspicion has to be not, and that his promise to keep progress towards economic convergence under review for the remainder of this parliament was mainly a concession to the prime minister. But the doubts, and uncertainties, will persist. With a fair wind and a referendum next year, euro entry could take place as early as 2005.

More likely it will take far longer, until 2008 or beyond. Depending on economic and political circumstances both in Britain and the euro zone, it might yet not happen at all. Logically, entry is considerably closer now than it was in 1997. As far as business is concerned, however, it is still a case of planning for an uncertain future.

A big part of that uncertainty relates to the housing market. In his statement Brown said that most of the “stop-go” problems of the British economy over the past 50 years had their roots in housing market instability. For those yearning for early euro entry, it is an enormous source of frustration that the boom-bust tendencies of the housing market, particularly in the south-east, are holding up progress. According to the Treasury’s detailed studies, housing is a “high risk” factor when it comes to joining the single currency.

For everybody else, and for the government, housing is something that needs to be fixed irrespective of its role in the euro decision. If housing volatility has generated overall economic volatility, as it plainly has, a government riding with a “no more boom and bust” pledge, has every incentive to try to permanently damp down housing market fluctuations. For business, having for years seen housing as the main cause of the two-tier economy (strong consumption, weaker production) the need for reform is no less pressing.

According to the Treasury, in its study, ‘Housing, consumption and Emu’, there are two essential differences between Britain’s housing market and those in euroland (although the study also notes that are important differences within euroland). One of those differences, contrary to popular impression, does not relate to levels of owner-occupation. Although the UK’s 70 per cent owner-occupation rate is higher than Germany (just over 40 per cent) and France (55 per cent), it is close to the EU average and below Luxembourg, Belgium, Greece, Ireland and Spain.

Instead, one of the big differences relates to how we buy our houses. In the UK more than 60 per cent of mortgages are variable rate, and thus sensitive to changes in monetary policy. The rest are on short-term fixed rates. This contrasts, say, with Germany, where 80 per cent of mortgages are on long-term fixed rates of more than five years, with the rest on short-term fixes, and France, where 60 per cent are on long-term fixed rates, the remainder short-term. Add in the fact that Britain’s mortgage debt is significantly high than the EU average, at 60 per cent of GDP, and you have a high degree of household sensitivity to interest rates changes.

Politically this is important because, inside the euro, such an important element in household budgets would be decided outside Britain, setting up the risk of a backlash. Economically it matters because the European Central Bank would only play small attention to the UK housing market in setting rates. Even outside the euro, it is undoubtedly the case that if the Bank of England was not constantly worried about sparking a housing boom, or exacerbating one, base rates could have been lower than they have been.

Professor David Miles of Imperial College London, who has been asked by the chancellor to report on the scope for developing a long-term fixed rate mortgage market in Britain, has an important task on his hands. He will provide an interim report for the November pre-budget report and is likely to point out that there are important differences even between countries where such mortgages are the norm.

In Germany, a long-term fixed rate mortgage tends to mean just that – the borrower is normally locked in for the full-term. In America, the long-term mortgage market has given rise to a mortgage-backed bond market and, via the operations of the agencies Fannie Mae and Freddie Mac, such mortgages are seen as having implicit government backing, hence their highly competitive rates. But the long-term in America’s mortgage market does not mean for ever.

In the past few years there has been a re-mortgaging boom, which has helped to sustain consumer spending, as borrowers have switched out of their existing fixes to lower rates. That kind of market might have a lot of appeal in Britain but it would not necessarily make our housing market more like those in Europe.

An even tougher problem relates to housing supply, the subject of a second Treasury investigation by Kate Barker of the Bank of England’s monetary policy committee, and formerly of the CBI. Annual investment in housing has dropped from 6 per cent of GDP 30 years ago to 3 per cent now. Annual new housing completions are running at about 0.7 per cent of the existing housing stock. Put another way, house-building is running at around 160,000 new homes a year, the lowest peacetime level since the 1920s, while housing demand would require new-build of at least 220,000.

Part of the reason for the decline in house-building, of course, has been the sharp scaling-back of the public sector’s role. The fact remains, however, that Britain has had a chronic problem of under-supply, and this has contributed to the fact that over the past 30 years real house price inflation has averaged 3.3 per cent a year, the highest in the EU, compared with 1.2 per cent in France, 0.1 per cent in Germany and Sweden. For those who own it, housing in the UK has been a pretty good investment.

Can under-supply be fixed? Among the things Barker is likely to advise is easing up on planning constraints. Ministers talk of forcing through many more new housing developments against local objections. Politically, that may be easier said than done. Identifying Britain’s housing problem is easier than fixing it.

From Business Voice, July-August 2003

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