When housing bubbles burst, misery results. Prudential curbs on lending must be introduced now to cool an overheated market

Economic View: Monetary policy is now too loose, given that the economy seems to be growing at a rate of about 4 per cent

So what will stop the house price boom – prudential controls on lending, or higher interest rates? Actually, it will probably be a bit of both but the more effective the former, the less the burden will be on the latter.

Something has to stop it. In the long run the only sensible policy will be to build more homes, at least 250,000 a year, and build them in the places where people want to live. But in the short and medium-term something has to cap the rise for all sorts of reasons. You cannot have prices rising by 10 per cent a year when incomes rise by 2 per cent without grave social and economic consequences. When the bubble inevitably bursts, misery results.

Yet the immediate outlook is for another year of rising prices. Not only do very low interest rates make the cost of servicing housing debt quite affordable; the latest survey from Royal Institution of Chartered Surveyors suggests that the present very strong run of prices has at least another 18 months to go, and its members expect 6 per cent annual increases for the next five years. You can see the link between Rics surveys and prices over the past 20 years in the graph: strong survey data gives a lead indicator of what might happen to prices.

Everyone is worrying about this. The Organisation for Economic Cooperation and Development is worried, the Bank of England is worried, even the Chancellor is worried, notwithstanding the modest push from Help to Buy – though on a one-year view rising house prices may not be bad news for the Coalition. So what will happen?

The first question is what effect new prudential rules on lending will have. In a nutshell, lenders have to assure themselves that the loan they are making is in the self-interest of the borrower and that they will be able to service the loan. Now you may think that this would be the most elementary thing any lender should do before making a loan, and until about 20 years ago this was generally what they did. That went from the late 1990s onwards. Now it is being revived and in the past couple of months there has been a slackening in the pace of new mortgages. There will probably be further curbs on home lending in the next few weeks – they are under discussion.

Will we also need higher interest rates? Yes, of course, but the issue is one of timing. If these curbs have failed to check the housing boom by the autumn, the first increase in rates will probably be brought forward to November. There are further reasons why this might be necessary; for example as the increase in construction costs, which currently seems to be running at 15 to 20 per cent a year, starts to feed through into inflation more widely. If, on the other hand, there are signs in the autumn that house prices are topping out and inflation remains below target, the first increase in rates will be delayed until next year, probably February.

The more important message that Mark Carney, the Governor of the Bank of England, and some other members of the Monetary Policy Committee have been seeking to get across is that even when rates do start to rise, the increases will be modest. The new normal for short-term rates might be in the 2 to 3 per cent region, rather than the 4 to 5 per cent range that they were generally prior to the crisis. That makes some sense for the business community and if you go back to the 1950s or early 1960s, before the great inflation took off, this would indeed be normal. The signal it gives to home buyers, though, is that they are reasonably safe remaining highly geared, or in plainer language, over-borrowed.

You don't want to have interest rates higher than they need to be, and the rise in sterling (now only a whisker below $1.70 and close to its year's high against the euro) has the effect of tightening policy. But some of us believe more generally that monetary policy is now too loose, given that the economy seems to be growing at an annual rate of around 4 per cent and putting on jobs at a rate of around one million a year. This is well above the long-term sustainable trend and while it is great to be mopping up spare capacity, it is worrying just how quickly that capacity, for example in construction, is being used up. I suppose there is not much practical difference between an increase in rates coming in November or coming in February, but I think it is important for the Bank to signal that it cares about asset inflation as well as current inflation. Andy Haldane, soon to become the chief economist there, made some thoughtful remarks a few days ago on the need to pay attention to asset prices. Expect his concern to become a more important influence in framing monetary policy in the months ahead.

So what will happen? A middle-of-the-road view would run like this: there will indeed be further rises in house prices for another year or two, but at some stage this combination of greater prudential curbs on lending, plus somewhat higher rates, will put some sort of ceiling on overall price levels. However UK prices, particularly in London and the South-east, will remain high by world standards. Even if planning controls are eased, which they will be to some extent, demand will remain strong.

Politicians will respond, so schemes such as the Help to Buy one will remain in place for some time, a point made by Lombard Street Research in a paper out yesterday. Eventually the market will plateau, and the sooner that happens the less likelihood there is of yet another bust.

Start your day with The Independent, sign up for daily news emails
ebooks
ebooksA special investigation by Andy McSmith
  • Get to the point
Latest stories from i100
Have you tried new the Independent Digital Edition apps?
Independent Dating
and  

By clicking 'Search' you
are agreeing to our
Terms of Use.

iJobs Job Widget
iJobs Money & Business

Ashdown Group: Editor-in-chief - Financial Services - City, London

£60000 - £70000 per annum + benefits : Ashdown Group: A highly successful, glo...

Guru Careers: Pricing Analyst

£30 - 35k (DOE): Guru Careers: We are seeking a Pricing Analyst with experienc...

Ashdown Group: Treasury Assistant - Accounts Assistant - London, Old Street

£24000 - £26000 per annum + benefits : Ashdown Group: A highly successful, glo...

Ashdown Group: Sales Team Leader - Wakefield, West Yorkshire

£21000 - £24000 per annum: Ashdown Group: The Ashdown Group has been engaged b...

Day In a Page

Revealed: Why Mohammed Emwazi chose the 'safe option' of fighting for Isis, rather than following his friends to al-Shabaab in Somalia

Why Mohammed Emwazi chose Isis

His friends were betrayed and killed by al-Shabaab
'The solution can never be to impassively watch on while desperate people drown'
An open letter to David Cameron: Building fortress Europe has had deadly results

Open letter to David Cameron

Building the walls of fortress Europe has had deadly results
Tory candidates' tweets not as 'spontaneous' as they seem - you don't say!

You don't say!

Tory candidates' election tweets not as 'spontaneous' as they appear
Mubi: Netflix for people who want to stop just watching trash

So what is Mubi?

Netflix for people who want to stop just watching trash all the time
The impossible job: how to follow Kevin Spacey?

The hardest job in theatre?

How to follow Kevin Spacey
Armenian genocide: To continue to deny the truth of this mass human cruelty is close to a criminal lie

Armenian genocide and the 'good Turks'

To continue to deny the truth of this mass human cruelty is close to a criminal lie
Lou Reed: The truth about the singer's upbringing beyond the biographers' and memoirists' myths

'Lou needed care, but what he got was ECT'

The truth about the singer's upbringing beyond
Migrant boat disaster: This human tragedy has been brewing for four years and EU states can't say they were not warned

This human tragedy has been brewing for years

EU states can't say they were not warned
Women's sportswear: From tackling a marathon to a jog in the park, the right kit can help

Women's sportswear

From tackling a marathon to a jog in the park, the right kit can help
Hillary Clinton's outfits will be as important as her policies in her presidential bid

Clinton's clothes

Like it or not, her outfits will be as important as her policies
NHS struggling to monitor the safety and efficacy of its services outsourced to private providers

Who's monitoring the outsourced NHS services?

A report finds that private firms are not being properly assessed for their quality of care
Zac Goldsmith: 'I'll trigger a by-election over Heathrow'

Zac Goldsmith: 'I'll trigger a by-election over Heathrow'

The Tory MP said he did not want to stand again unless his party's manifesto ruled out a third runway. But he's doing so. Watch this space
How do Greek voters feel about Syriza's backtracking on its anti-austerity pledge?

How do Greeks feel about Syriza?

Five voters from different backgrounds tell us what they expect from Syriza's charismatic leader Alexis Tsipras
From Iraq to Libya and Syria: The wars that come back to haunt us

The wars that come back to haunt us

David Cameron should not escape blame for his role in conflicts that are still raging, argues Patrick Cockburn
Sam Baker and Lauren Laverne: Too busy to surf? Head to The Pool

Too busy to surf? Head to The Pool

A new website is trying to declutter the internet to help busy women. Holly Williams meets the founders