We’re one step closer to rising rates – that’s bad news for property

Is the ‘unreliable boyfriend’ about to be tamed?

Two weeks ago, we said there was a good chance that one or two members of the Bank of England’s Monetary Policy Committee (MPC) would vote to hike rates, for the first time since 2011.

Sure enough, yesterday’s minutes show that two (Ian McCafferty and Martin Weale) voted to raise rates to 0.75%.

What’s more, Governor Mark Carney seems to be getting more hawkish. After apparently saying that rates wouldn’t rise until there was stronger wage growth, he said last week that this wouldn’t be necessary.

The exact timing of a rate rise is no clearer. But what is clear is that the era of zero interest rates in the UK is drawing to a close.

And the UK property market already seems to be dreading the prospect.

A pair of rebels at the Bank of England

The fact that not one but two members of the MPC broke with Carney on interest rates this month, is a clear signal that this isn’t just one lone maverick.

So why did McCafferty and Weale want to hike rates? They’re worried that “the continuing rapid fall in unemployment alongside survey evidence of tightening in the labour market created a prospect that wage growth would pick up”.

They don’t think the Bank should wait to see wages increase strongly before raising rates. Echoing what my colleague John Stepek said the other day, wages are “lagging developments in the labour market” and “might not start to rise until spare capacity in the labour market were fully used up”.

As a result, the Bank should “anticipate labour market pressures by raising Bank Rate in advance of them”. The rest of the committee don’t agree – at least not yet. However, the Bank did cut its estimate of spare capacity (the amount that the economy can grow without raising inflation) to 1%. This implies that rate rises are closer than many people think.

Of course, there’s a two-week gap between the meeting and the minutes. And since then, annual inflation (as measured by the consumer price index) has dropped from 1.9% to 1.6%.

Alongside weak wage growth, this would normally suggest there is still a lot of spare capacity in the UK economy, allowing the Bank to boost growth without pushing up prices.

But if you take a closer look at the figures, inflation still seems to be a potential threat. As Professor John Thanassoulis of Warwick University points out, July’s figures were distorted by various short-term factors.

Summer sales started later than usual – so prices were higher in June and lower in July. He adds that the price war between the discount supermarkets Aldi and Lidl may also be keeping prices low.

Both of these factors are temporary and should reverse, pushing inflation up again.

Even the prospect of rising rates is bad news for the property market

Opinion is split in the MoneyWeek office as to whether rates will rise before or after the election. But I think we’d all agree that it seems very unlikely that rates will still be at 0.5% come the second half of 2015.

Rising rates of course have an impact on every asset – but few look more vulnerable right now than property.

Up until now, low interest rates have been the one thing holding the London property market together. Rock bottom rates have kept mortgage payments affordable, even in the face of record property prices.

The same low rates have also encouraged people to shift money into rental properties, in the hope of getting a better return than is available on lower-risk investments like government bonds.

When rates go up, this process is likely to go into reverse, especially in the capital. The Mortgage Market Review has tried to shut the stable door on dodgy loans by forcing banks to carry out ‘stress tests’ on new lending. But it’s only been in operation since April. So there are still likely to be many people who will find it hard to cope with the impact of rising rates on the monthly loan repayments.

For example, a recent Halifax survey suggests that 39% of mortgage holders in London say that they would have to cut back substantially on their spending elsewhere, if their mortgage repayments went up by £100 a month.

London’s property market is already coming off the boil

And the mere threat of higher rates already seems to be feeding into the London market. Online estate agent Rightmove reckons that asking prices fell by just under 6% in London from July to August, and dropped by 2.9% overall.

This might be partly down to weak activity in the summer months (Rightmove’s figures are not adjusted for the time of year). But the fall is far bigger than in previous years, including even in 2007, when the last bubble was imploding.

The survey also suggests that far more properties are coming onto the market, as homeowners look to cash in before prices fall.

I suspect that the foreign property owners on whom the London market is so dependent will also be keeping a close eye on prices. Between a stronger pound and surging prices, they’ve made a lot of money in a short space of time. With political risk rising (if you want to raise a lot of tax in a politically popular manner, then rich foreigners are a good target), and a potential turning point for prices dead ahead, now might look a good time to cash in.

Of course, Carney is aware of all this. It’s one reason why he’s been so keen to keep rates as low as he can for as long as he can. And it’s hard to see the MPC pulling off a full-blown rebellion on the new governor.

But it’s only a matter of time before rates start to rise. And history suggests that when house prices peak, they don’t just plateau – they tend to fall hard before they stabilise. Good news for those looking to buy – but bad news for property owners.

• This article is taken from our free daily investment email, Money Morning. Sign up to Money Morning here.

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