Bank of England and IMF on a collision course over house prices

The economy should survive the impact of a crash in house prices, the Bank of England said in a study published today.

The economy should survive the impact of a crash in house prices, the Bank of England said in a study published today.

While it admitted that soaring levels of debt and house price inflation had loud echoes of the 1980s, when a similar boom ended in a recessionary crash, the Bank said it believed the economy was on a much sturdier footing now. The study came just hours after the International Monetary Fund, the global financial watchdog, warned that the UK could suffer another property crash.

The two reports mark the latest clash between the UK authorities and the IMF over the fate of the housing market, which economists agree will be one of the most pressing economic issues for policymakers in the run-up to a likely general election next spring.

It is the third time in recent years that the IMF has warned of a fall in UK prices and this time it has published just ahead of the meeting of the Group of Eight nations that includes the UK. It might lead to a frosty exchange between Gordon Brown, who is chairman of the IMF's monetary and financial committee as well as Chancellor of the Exchequer, and senior officials at the IMF when he flies into Washington next week.

The Treasury was keen to play down the impact of the IMF report yesterday, saying that households had much stronger balance sheets than they did two decades ago. A spokeswoman said its position had not changed since June when Ed Balls, then the Chancellor's chief economic adviser, said: "There are important reasons to believe that households' overall balance sheets are and will remain consistent with macroeconomic stability."

The Bank's analysis supported Mr Balls' view, saying both unemployment and interest rates were much lower than they were in the 1980s - and were expected to stay so. It also pointed out that significantly fewer new mortgages had a loan to value ratio (LTV) greater than 100 per cent - where the loan is greater than the house price, while even the numbers with 80 or 90 per cent LTVs has fallen "sharply".

The Bank said: "The distribution of debt across new borrowers suggests that if there was a fall in house prices, fewer households than in the 1980s would be likely to face problems borrowing and the number of households experiencing negative equity would be lower."

The paper, published in the Bank's quarterly bulletin and written by two of its economists, also points out that fewer transactions than in the 1980s meant fewer people had bought a home near the peak of the boom.

In addition the authors argue that in recent years households have matched their appetite for debt with a willingness to build up their financial assets, providing a cushion against a fall in house prices. They said: "So unless households face an unexpected large negative shock - for example that unemployment or interest rates rise substantially more than they expect - the risks ... are lower than in the past."

The key issue is whether there will be a house price crash. The Bank has consistently argued that house price inflation will slow to zero in two years, although it has been forced to push the deadline back as house price inflation has refused to subside.

The IMF has taken a different stance, issuing a gloomy warning over housing markets in the UK and many other countries. It said that houses in Britain were overvalued by as much as 20 per cent and a crash in prices could "not be ruled out" as interest rates continued to rise.

According to its twice-yearly world economic outlook: "For the UK, a drop in house prices cannot be ruled out, reflecting the higher forecasting uncertainty in that country. The evidence suggests that current house prices appear out of line with fundamentals in some countries, including the UK, highlighting the risk of a more pronounced drop in prices." Its analysis showed that prices had nearly doubled since 1997 and the UK had posted the largest average annual increase of any major country between 1971 and 2003.

It analysed the traditional causes for rising house prices - interest rates, income growth, affordability and lending growth - but found they could not explain the increase. David Robinson, the deputy director of the IMF's research department, said: "There's a fairly large chunk that we cannot explain - I think of the order of 15 to 20 per cent. That's the reason why we conclude that there may be overvaluation of house prices in the UK relative to fundamentals."

The National Association of Estate Agents said the IMF had got it "badly wrong". Peter Bolton King, its chief executive, said: "The IMF has not taken into account the fact that there is a desperate shortage of new housing in the UK." He acknowledged that house prices were probably too high but said with average incomes growing by 4.5 per cent it would only take four years for the ratio between house prices and incomes to come back into line with the long run average.

"We believe the IMF is needlessly flying a kite and scaring homeowners," he said. The small print of the IMF report revealed it was based on interest rates hitting 5.5 per cent, a view now supported by a only minority of economists.

One of those, John Butler at HSBC, said he carried out a similar exercise 18 months ago, including a measure of the housing shortage, and found that between 10 and 15 per cent of the house prices growth could not be explained by economic fundamentals. "I would agree with the IMF's conclusions [that property's overvalued] but I think you need a trigger for a crash and I don't know what that would be," he said. "So I think we will get five years of house prices going nowhere."

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