Thursday, November 09, 2006
5%, no surprise
Posted by David Smith at 12:05 PM
Category: Thoughts and responses

As expected, the MPC raised interest rates to 5%. Here's the statement. They're quite upbeat about the economy:

"The Bank of England’s Monetary Policy Committee today voted to raise the official Bank Rate paid on commercial bank reserves by 0.25 percentage points to 5.0%.

The UK economy has recorded its fourth consecutive quarter of firm growth. Household spending has been volatile, but the underlying picture appears to be one of moderate expansion. The recovery in business investment has been maintained. The outlook for growth in the United Kingdom’s main export markets remains positive. Credit and broad money growth remain rapid, and asset prices have continued to rise.

Although unemployment has continued to edge up, the margin of spare capacity within businesses appears limited. Oil prices have dropped back, but there are signs that other pricing pressures have picked up. CPI inflation was 2.4% in September. It is likely that inflation will rise further above the target in the near term, but then fall back as energy and import price inflation abate.

Against that background, the Committee judged that an increase in Bank Rate of 0.25 percentage points to 5.0% was necessary to bring CPI inflation back to the target in the medium term."


No surprise but pretty depressing - particularly the way economic commentators immediately launch into speculation regarding the next rise in February, virtually willing the outcome. Back in 2004 two consecutive monthly quarter point base rate rises managed to knacker the housing market and consumption very successfully and it was only the August 2005 quarter point cut that reversed that trend. Currently hysteria centering on the London property market and a few City bonus recipients is grossly exaggerating what is really happening. Hometrack is on the button when it reckons 4.4% current house price inflation in the South East. Remove around 3.4% RPI inflation from this and the true picture does not look as exciting as it is painted.

Here is another conundrum - if the housing market is so marvellous why are there so few participants? According to the Land Registry the last 4 quarters recorded activity shows just over 1 million transactions. There are 14 million owner occupied homes in England and Wales; so such is the fervour regarding housing that people are moving once every 14 years! Back in the 1980's it was once every 5 years. It is surprising that with all the preoccupation with inflation, commentators seem to only note headline rates when it comes to housing. People in general fall into this trap - simply deducting what they originally paid for a place from today's achievable price. The average property in 1995 was worth £60,000 - now it is worth £180,000. Shoot me down in flames, but the value of money has halved in the last 11 years so call £180,000 £90,000, the profit £30,000 and the real annual gain about 5%. In real terms over the last 60 years the average gain has been around 4% pa.

Back to interest rates – net incomes are declining, the Bulgars and Romanians will be joining the 750,000 Poles here officially or otherwise and incomes are unlikely to inflate dangerously. The biggest capital repayments ever recorded on credit cards in September shows the way the wind is blowing and retail, as you have already commented, has already started to suffer. Once the mortgage statements fall through the letter boxes the property market will slow down markedly – August and November’s impacts will take a little time – just like the August 2005 cut took until about December to sink in and animate the market. The only mystery regarding the Bank of England is the Governor’s perplexity regarding the perceived exuberance of the property market when it comes to multiples of average incomes. Surely the main drivers are disillusioned investors who will no longer touch low yielding pensions or poor performing retail investment products – highly leveraged, self certified (in more than one sense) ‘buy to let’ purchasers. The group who the ONS stated have provided the biggest single contribution to GDP growth in the last 15 years.

Posted by: Alan Tayler at November 9, 2006 03:33 PM