This feature is part of our FREE daily Money Morning email. If you’d like to sign up, please click here: sign up for
Money Morning
.
It‘s that time of the month again, when all eyes fall on the Bank of England as it deliberates on interest rates.
The latest decision from the Monetary Policy Committee is out at noon, and by a minute past 12, the UK base rate will almost certainly be 5%.
And there’s an increasing consensus among economists that we’re nowhere near the end of the road for rate rises yet…
The shadow MPC, which meets ahead of the real thing, under the auspices of Lombard, also voted for a rate rise this month. But two of its members actually voted for a half-point rise, which shows just how concerned some experts are about inflationary pressures.
And The Times’s own panel has also voted for a quarter point hike. Key concerns include the sharp rise in retail price index inflation (RPI), which now stands at 3.6%. RPI tends to be the focus of wage negotiators. If it continues to rise, growing wage inflation could be the result, particularly as pressure mounts in the public sector, where unions are already making threatening noises amid attempts by the Government to keep the coming round of pay rises to below 2%.
Even Roger Bootle, of Capital Economics, who wrote ‘The Death of Inflation’, predicting the current low rate, low inflation environment more than ten years ago, now believes that central banks around the world will have to keep interest rates higher, and for longer than most people expect, if we want to keep inflation down.
Another big worry is the ongoing buoyancy of the housing market. Even the Royal Institution of Chartered Surveyors is backing a rate rise, saying that cheap borrowing has helped to inflate house prices. Of course, the group may simply be accepting that a rise this month is inevitable – better one now than more further down the line. But not all the property pundits can bring themselves to accept the inevitable.
Stuart Law of property investment group Assetz reckons that rising house prices aren’t due to softer interest rates, but are in fact mostly a function of supply and demand. He admonishes Rics, saying: “It would take excessively high levels of interest rates to prevent the supply / demand imbalance from driving up prices.”
This is of course, much more in line with the typical response you’d expect from a business which relies on rising property prices for its profits. But the argument is clearly wrong. The fact that there are now so many weird and not-so-wonderful ways to overstretch yourself to get on the housing ladder shows that easy lending is the reason for the continued boom.
If buyers are unable to get a mortgage, they can’t then afford to buy a property. If enough people stop being able to buy property, then prices have to fall until they reach a point where they are once again affordable.
But lenders have continually relaxed their lending criteria, which has allowed prices to continue to soar. The trouble is, this means that the borrower (and the lender for that matter), is taking on increasing levels of risk.
Website MoneyExpert has reported that a third of lenders now offer mortgages with terms of 40 years or more. Tesco goes all the way to 52 years in some cases. And first-time buyers are among the groups most likely to be targeted.
One of the reasons why people often say buying is better than renting is “because once you’ve paid off the mortgage, it’s yours.” But nowadays, the average first-time buyer is in their thirties. How many of them will live long enough to see the end of a 52-year mortgage? How many will still be able to pay the mortgage bill out of their state pension?
The longer the term, and the larger the amount borrowed relative to income, the riskier the loan becomes,. As Keith Tondeur of Credit Action tells The Times: “Lenders are coming up with more ingenious ways to sustain a house price boom that is not sustainable. The only way to afford property now is to be saddled with debt for life. But if something goes wrong, such as a rise in interest rates or a fall in house prices, then these moves could prove catastrophic.”
And as Nick Gardner of Chase de Vere points out: “Longer terms are a false economy. The monthly savings are relatively small but result in vast sums of extra interest. The message to borrowers is, ‘Don’t do it.’”
As long as lenders keep trying to gather more business by lowering lending standards ever further, the housing bubble will continue to inflate. But at some point – possibly within the next few interest rate rises – those who have already overstretched themselves will start to feel the pain, and the default rate will rise more sharply. And then lenders – just as they did with credit card lending – will see their bad debts soaring, panic, and ditch all their ’innovative’ new products.
And that’s when house prices will have to fall towards more affordable levels.
Just before we go, we saw a touching piece in City AM this morning, which – we think you’ll agree – provides a heart-warming tribute to the sacrifices our noble leaders are willing to make for the voting public.
“MPs boycott HBOS in fury over Farepak” screams the headline. Scots MPs apparently don’t think that HBOS’s contribution of £2m to the Farepak rescue fund is enough (for more on the Farepak case, see Merryn Somerset Webb’s recent comments, by clicking here: How Christmas savings schemes exploit the financially ignorant. So are they withdrawing their mortgages, investments and savings accounts from the Edinburgh-based banking giant?
No. They’re thinking of not turning up to HBOS’s Christmas champagne reception.
Given the dearth of such events around the Christmas season, and the general absence of opportunities for MPs to quaff free champagne (and at the expense of shareholders, rather than the taxpayer!), we’re sure the Scottish people and Farepak’s customers will appreciate the heroic gesture their MPs are considering making on their behalf.
We’ll be sure to raise a toast to them at MoneyWeek’s Christmas do.
Turning to the stock markets…
Enjoying this article? Why not sign up to receive Money Morning FREE every weekday? Just click here:
Money Morning
.
In London yesterday, a late rally nearly allowed the FTSE 100 to recover heavy losses sustained earlier in the day. The blue-chip index ended that day 5 points lower, at 6,239, having hit an intra-day low of 6,205. Scottish Power‘s share price jumped by over 8% – making it the day’s biggest riser – after the electricity supplier confirmed it was the subject of bid interest, although declined to say by whom and at what price. (It was suggested last night that the interested party was Spanish firm Iberdrola). For a full market report, read: London market close
Elsewhere in Europe, the Paris CAC-40 closed a fraction of a point lower, at 5,437. In Frankfurt, the DAX-30 was 12 points lower, at 6,349.
After initial uncertainty on Wall Street as to what the new US political landscape will mean for markets, stocks went on to end the day higher. The Dow Jones set a new record close of 12,176 after rising 19 points. The Nasdaq climbed 9 points to close at 2,384, its best level in nearly six years. The S&P 500 was also higher, gaining two points to close at 1,385.
In Asia, the Nikkei closed 17 points lower, at 16,198.
The price ofcrude oil was back above $60 this morning, last trading at $60.03. In London, Brent spot was at $57.63 a barrel.
Spot gold was quoted at $615.20 in New York late last night. Silver had edged up to $12.48 today.
And in London this morning, the world’s largest publicly listed hedge fund manager, Man Group, announced first half profits of 40%, even though some of its biggest funds had lost money in the six-month period to September. The group’s revenue was boosted by net inflows of $7bn and rising income from fees. Shares in Man Group had fallen by as much as 8p this morning.
And our two recommended articles for today…
How to play the next stage of the gold cycle
– We are going to move into the most profitable stage of the gold rally – stage three – any time now. If you want to know what signs you should look out for – and whether is a good time to invest in gold mining stocks – see: How to play the next stage of the gold cycle
The US housing market and domino economics
– Domino economics is the simplest of all concepts: when one domino falls an adjacent domino will subsequently fall and so on and so forth. One domino on its way down is the US housing market – but what will fall next? To find out what the direct consequences of the housing slump are – and the longer-term effects we could see – read: The US housing market and domino economics