House buying and the global economy

The popular and much touted view is that UK’s interest rates will be increased by another quarter point in July, and then again before the end of the year. This is he view that commentators believe will finally have a moderating effect on house-price inflation.

In the United States prices for new homes are on their way down – by 11% – the biggest fall since 1970. Builders are trying to shift homes to generate cash flow. This kind of decrease was certainly not predicted.

Forecasting what will happen to house prices has become ever more difficult with the globalization of the market. Thus buying a home has more than the Bank of England and its Monetary Policy Committee (MPC) affecting it. Include the European Bank, Tokyo, Beijing and Washington.

It may be hard to take that people from so far away can have an impact on what your monthly mortgage repayments will be, but that is the way of the world. The influences of India and China on the world economy are being felt and will be for many years to come. For example low-cost goods from China and low cost services from India have helped to keep the lid on global inflation and interest rates and led to the best economic conditions since the 1960s.

But this good news is now tempered with the realization that the world’s open capital markets have led to difficulties in controlling the domestic economy. Banks can make changes for its own people, but not everyone worldwide is affected by those changes. Thus, the impact of the changes is uncertain.

On example was in the early 1990s when the Japanese economy was suffering and interest rates fell to zero. What happened was that international investors moved in, borrowed cheap yen and took the money overseas to invest in other currencies. Much of the money ended up in London, where the inflow pushed up the pound, made imports cheaper, exports more expensive, and pressed inflation down. But the economy was knocked by cheaper consumption and dearer exports. Should the MPC cut bank rates to prevent undercutting the inflation target? Or should they hold bank rates to cope with the money supply and risk more money coming in to further imbalance the economy?

The existence of a single global capital market and a common drive for price stability has led to long-term interest rates in Britain, the US and Germany all being the same. Countries such as China, Japan and Saudi Arabia are running at a surplus, putting more money on the capital markets and drawing long-term interest rates down. This means that when the Bank of England raises its interest rates, there is no certainty that long-term interest rates will follow suit. Quite the opposite may occur: if the market sees that putting up base rates will slow growth and reduce inflation – as it’s designed to do – long-term interest rates may go down.

It means that central banks can no longer be fully confident that their rate changes will have the expected effect on the economy as forecast by their models.

Another complication is that growth in India and China has pushed up the cost of commodities, in turn pushing up the cost of living. The MPC has to consider whether this is inflationary, thus pushing up wage demands, or deflationary, thus reducing people’s disposable incomes.

What is the impact for the ordinary house buyer?

Four interest rates since last August have not yet have the desired effect, even though their full impact has yet to be seen. Governor Mervyn King has given a very clear indication that rates are going to rise again. With a lot of re-mortgages due in the coming few months, the Bank must be fearful that another rate rise could have a dramatic and immediate effect – beyond that which is desired. The belief that failure to act now will lead to rates higher than 6% in the medium term is ultimately likely to prove too strong to ignore, especially as June’s MPC vote was so close to putting rates up.

A home buyer should take on board a clear message. Property is still very expensive and the cost of having a mortgage is rising. As Mervyn King advised: consider whether you could afford your repayments if rates went up another 1%. Also, consider your employment position: where will you be in twelve months. Caution is advised.

Property website Hometrack believes that the turning point in the housing market has been reached, and interest rate rises are having an impact. Rises in May were only 0.6%, down from 0.7% in April, and annual inflation for house prices was down to 6.7%. There has been some softening of demand with an increase in supply, mainly due to people’s wish to avoid the need for Home Information Packs.