Boom or bust; where next for the housing market?

Interest rates are rising but the effect on home sales is still uncertain, says William Kay

Mervyn King, governor of the Bank of England, did his best this week to scare house buyers into cooling down. He told a CBI dinner in Glasgow: "After the hectic pace of price rises over the past year, it is clear that the chances of falls in house prices are greater than they were."

Mervyn King, governor of the Bank of England, did his best this week to scare house buyers into cooling down. He told a CBI dinner in Glasgow: "After the hectic pace of price rises over the past year, it is clear that the chances of falls in house prices are greater than they were."

It was as if Mr King had taken to heart my prediction last week that he would follow the base rate rises of the past two months with a blunter warning, maybe on the lines of "Are you all deaf or what? Stop borrowing or we'll turn really nasty".

In more measured tones, the governor actually said: "Demographic factors, a shortage of housing supply and low levels of inflation and interest rates, all mean that the sustainable ratio has probably risen somewhat over the past decade. Nevertheless, it is now at levels which are well above what most people would regard as sustainable in the longer term. So anyone entering or moving within the housing market should consider carefully the possible future paths of both house prices and interest rates."

Ed Balls, Chief Economic Adviser to the Treasury, moved swiftly to dampen the effect of Mr King's message. Speaking at the Chartered Institute of Housing annual conference, Mr Balls said: "While a moderation in the house price-earnings ratio is widely expected by the Treasury and other forecasters, household balance sheets are strong and inflation is low. While vigilant to the risks, it is because of Britain's forward-looking and pre-emptive approach that this adjustment is expected to occur in a steady way consistent with stability and sustained economic recovery."

But commentators unanimously agree that the future path of interest rates is going only one way: Up. The only question is how long it will take for that to level off the path of rising house prices, or even possibly to precipitate a fall.

Mike Felton, manager of the ISIS UK Prime fund, said that Mr King's comments were widely interpreted as signalling the growing risk of a crash in the housing market, as well as indicating that interest rates would be raised further in an attempt to slow house price inflation.

But the Bank of England has an uphill task. A survey from the highly respected Joseph Rowntree Foundation found that most parents believe they will have to give their children cash help to clamber onto the housing ladder. The research found that on average they expect to chip in £17,000 per child, either through a loan or gift. From the point of view of the market as a whole, that is only fuelling the amount those children can afford to bid for their first homes.

In many ways, Mr King was simply stating the obvious. When he raised interest rates a month ago, he said: "Retail spending continues to be robust, underpinned by income growth and unexpectedly strong house price inflation."

Ray Boulger, housing expert with the financial adviser Charcol, said: "It's hard to disagree with Mr King's remarks. He did not say the housing market was going to crash, nor how far interest rates were going to go up. It's a fairly obvious statement of fact that the more prices go up the more likelihood there is that they are going to come down. When the governor says this sort of thing, people sit up, but they have usually forgotten all about it within two or three weeks unless he says it again and again: it's actions that have a real impact. Nevertheless, anyone thinking of buying a house should factor in the fact that rates are going up."

Mr Felton believes that chances of an outright housing crash are slim. He said: "Admittedly it's unusual for any market that has enjoyed the sort of rampant growth that we've seen in house prices to experience a managed correction rather than a crash. But unless interest rates rise to a level far higher than current expectations and unemployment also rises sharply, neither of which we believe are remotely likely, then there is little fundamental reason why house prices should crash."

As so often happens near the top of a market, the signals are becoming mixed. While the Halifax and Nationwide surveys are still showing a 20 per cent annual rise in house prices, the Office of the Deputy Prime Minister's survey, based on the Land Registry, is much more modest. And two trade bodies suggest that the heat may be coming out of the boom. The National Association of Estate Agents is reporting inquiries beginning to tumble, and the latest report from the Royal Institution of Chartered Surveyors (RICS), suggests that new buyer enquiries are falling and completed sales are also slowing.

The RICS said: "The housing market has performed so well and for so long that many have come to see it as the goose that lays the golden egg, and even risk free. However, the market is subject to change depending on the wider economy.

"Given the strength in the global economy, this may mean interest rates continuing to rise, perhaps by more than many have factored into their purchase decisions. Whether house prices actually decline depends on many other factors including the state of the labour market."

But Mr Felton sees this as a sign that rate rises are already beginning to have an impact. "This is the sort of pullback we have been looking for," he said.

Mr Boulger is confident that the Bank of England will stop short of triggering an actual house price crash.

He said: "The trick is to get house prices rising at just about 4 per cent a year, in line with earnings, but that is virtually impossible. Nevertheless, I don't think the Bank will push rates up to the point where we get falls in prices. That is the last thing the Bank wants because that would have big effects on the rest of the economy. Housing generates lots of other activity in other sectors, such as furniture, carpets, white goods, DIY, conservatories and so on."

HOUSING DOS AND DON'TS

* Don't be seduced by that "must have" dream home.

* Don't dip into the market unless you have a stable job with no imminent threat of relocation.

* Do work out what your mortgage repayments will be if base rate rises from 4.5 per cent to six per cent. See if you can still afford payments.

* Don't fall for fixed-rate mortgages: the rates price in future base rate rises, and you may still be paying the fix when base rates start falling.

* Do look at capped tracker mortgages, which track base rate but only up to a preset ceiling. Ray Boulger recommends one with Derbyshire Building Society, charging base rate plus 0.75 per cent, capped at 5.99 per cent, until 31 July 2009, up to 80 per cent of the property's value. Coventry Building Society has one until 31 December 2009, capped at 5.99 per cent. It charges base rate plus 0.85 per cent, but with no penalty for early repayment.