Of Mortgages And King

11/03/2011 at 3:11 pm

The economic data released for the UK so far this month illustrates an important dilemma for British monetary policy. On the one hand, purchasing manager surveys for the manufacturing and construction sectors showed increasing strength, equivalent data for the service sector confirmed that it is still growing, industrial production posted its strongest annual gain since the recovery of the early 1990s and price rises at the factory gate reached new post-recessionary highs. On the other hand, the Nationwide, Halifax and Hometrack house price measures all saw declines on the twelve months to February, mortgage market data still looked relatively weak and so did growth in unsecured lending to consumers. It looks all too clear that any increase in the base rate would exert further downward pressure on an already vulnerable housing market, knocking confidence and halting the UK’s recovery in its tracks.

Appearances, however, are deceptive. Yes, mortgage approvals are running at about half the average monthly rate of the last ten years (45,000 plays 90,000), but they are well off the low of 26,000 reached in November 2008 – and does the approval of 45,000 home loans each month really indicate a mortgage market that is – in any absolute sense – broken?

More important, perhaps, is the fact that bank lending rates and the theoretical margins available on mortgage lending have returned to normal levels. Bank of England data shows average variable rates on mortgages running at about 4%, pretty much where they have been for the last couple of years or so. Reducing this by 3-month LIBOR plus the spread at which European banks can borrow (as measured by the credit default swap market) gives a figure of about 1.5% – exactly where it was in March 2007, just as the subprime crisis was beginning to break. In other words, the average mortgage lender should be able to generate similar profits to the pre-crunch market, when over 100,000 UK mortgages were being approved each month. The dislocations in the interbank and credit markets which prevented this from happening even when SVRs were much higher are now ancient history.

Leaving the technical stuff aside, are lower house prices really such a bad thing anyway? Do we want to return to the era of 125% mortgages, debt-powered buy-to-let empires and ubiquitous small-scale “property development”? Or would we rather see genuine value-added economic growth, more affordable housing for first time buyers and strengthening consumer balance sheets – while accepting a limited amount of pain in the form of negative equity for the unluckiest / most reckless borrowers as a price worth paying to stop everyone suffering the consequences of runaway inflation?

It might even turn out in an ideal world that the prospect of higher UK rates attracted investors to the pound, mitigating the worst effects of imported commodity price inflation without actually having to tighten policy all that much.

The banking system is not the basket case it was a few years ago, the mortgage market is arguably less broken than it was in the heyday of Northern Rock, and another 0.25% or 0.5% on the cost of borrowing is most unlikely to kill everything off again. The worst of the emergency is over, and prices are rising rather sharply now. It is time for Mervyn King to recognise all this and act accordingly.

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