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Bank of England deputy governor warns of housing market economic ‘hazard light’

The return of rapidly rising property prices is the “brightest [hazard] light” threatening to derail the UK’s economic recovery, the deputy governor of the Bank of England has said.

In a speech to bankers in the City of London (8-page / 199KB PDF), Sir Jon Cunliffe gave the strongest indications yet of the central bank’s concern over spiralling house prices, both in London and in the rest of the UK. He said that although it remained to be seen whether the increase would in turn lead to higher levels of debt; it would be “dangerous to ignore the momentum” that had built up in the UK housing market over the last year.

“There is good reason to believe that a mutually reinforcing combination of strong demand, weak supply and expectations of a rising market could lead to a period of sustained and very powerful pressure on house prices in the UK,” he said.

“It would be dangerous to ignore the momentum that has built up in the UK housing market since the spring of last year. The extent to which that will jeopardise financial stability depends on whether that pressure actually results in more transactions at higher prices, whether that in turn leads to an increase in household indebtedness and where that debt is concentrated,” he said.

He said that the Financial Policy Committee (FPC), on which he sits, would have to decide whether to take action to address the rapid rate of growth in both prices and transactions as part of its ongoing role as the part of the Bank of England responsible for oversight of macroeconomic policy and ensuring financial stability.

UK house prices have risen by a further 10% on average in the year to March 2014, returning them to the levels that they reached in late 2006. Although this growth has been most pronounced in London, house prices rose by more than 5% in 10 out of 12 UK regions across the same period.

According to Cunliffe’s speech, rising consumer confidence and more readily available mortgage credit due to initiatives such as the government’s Help to Buy programme have contributed towards this growth. Although part of this could be attributable to pent-up demand in the aftermath of the financial crisis, the historical failure of new housing supply in the UK to keep pace with demand could continue to push up house prices significantly; a phenomenon that Cunliffe described in his speech as “a movie that has been seen more than once in the UK”.

On a positive note. Cunliffe said that UK lenders were better placed than they were to deal with economic shocks caused by house prices than they were before the financial crisis, in part because of new capital requirements forcing them to hold almost three times as much capital in reserve against residential mortgage liabilities. In addition, future ‘stress tests’ to be carried out by the Bank of England to measure the resilience of UK banks and building societies will be based on a drop in house prices by 35%, according to an announcement by the central bank last week.

The Help to Buy mortgage guarantee and shared equity loan schemes have contributed to concerns of another housing ‘bubble’, like the one that led to the initial economic crash in 2008. Now that the scheme has been running for a year, the FPC has the power to scrutinise its effects on financial stability and make recommendations to the Treasury and regulators, including the Financial Conduct Authority (FCA), about its future.

“The growing momentum in the housing market … has not yet been accompanied by a substantial increase in aggregate mortgage debt, though gross mortgage lending is growing and there are signs that debts are becoming more concentrated,” Cunliffe said.

“This could fade as affordability and lender constraints act increasingly as a brake on momentum. But other outcomes are very possible and the FPC will need to be both vigilant and ready to act,” he said.

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