Expert View: Mark Cliffe

Don't expect the Americans to pull in their belts
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The Independent Online

Some commentators argue that an imminent bursting of America's house price "bubble" means the peak in US rates could come much earlier than the markets expect. However, a UK-style consumer slowdown looks to be some way off. In contrast to the situation on this side of the pond, income growth in the US is accelerating. Combining this with the low level of long-term rates, it is hard to see America experiencing the housing market turnaround we've seen here. Indeed, at least for the rest of this year, the housing boom is likely to make the Fed more, not less, inclined to raise interest rates.

Yet it is striking just how dramatically opinions have changed on the UK. Earlier in the year, the majority view was that consumption would remain robust and that inflationary pressures would be enough to push the Bank of England into raising its key rate from 4.75 per cent to 5.25 per cent or even 5.5 per cent. The Bank itself mused that the housing market slowdown might have a minor impact.

In the event, the impact has been even bigger than expected: consumption rose only 0.1 per cent in the first quarter. With spending looking set to remain depressed, the markets have come round to the view that rates may fall to 4.25 per cent by year end.

It's also remarkable that the UK's slowdown has not been associated with either a dramatic fall in income growth or a sharp rise in interest rates. Disposable incomes are still growing at around 2.5 per cent, in line with the average of the past three years. Meanwhile, interest rates have risen by only 1.25 per cent from their mid-2003 low.

Given this, it is certainly possible that the markets may now be misreading the US. After all, the Fed has already raised rates by 2.25 per cent from their mid-2004 low, with the promise of more to come. Perhaps the housing market will crack, taking consumption with it as it has in the UK.

But there are precious few signs of this. If anything, American consumers are stepping up the pace of their spending after a "soft patch" in the spring. Despite renewed increases in oil prices, they are enjoying rising wages and employment. True, the taxman has become less friendly since President George Bush's first term, but disposable incomes are still growing at close to a 3.5 per cent rate.

Of course, as we've seen in the UK, strong income growth alone may not be enough to prevent a downturn. But two factors argue against this. First, US house prices have risen far less dramatically than in the UK. Since the start of 2001, they have risen by 49 per cent, compared with 89 per cent here. Even allowing for what the Fed's chairman, Alan Greenspan, describes as "local froth", valuations in the US do not look as stretched as they do in the UK.

More importantly, the fact that long-term interest rates have been flat or falling in the US means that borrowers have not been confronted with the extra mortgage costs seen in the UK, where most borrowing is linked to short-term rates.

In fact, in the near term, there's more reason to expect the US housing market and consumption to accelerate rather than decelerate. In any case, the Fed could reasonably point out that short-term rates in the US are still some 1.5 per cent below those in the UK in nominal terms, and 2.25 per cent allowing for inflation differences. This is likely to reinforce its determination to keep raising interest rates, despite the agonising about the housing bubble.

Mark Cliffe is chief economist at ING Financial Markets.