Outlook: Quarter point won't halt house price escalator

Hutchison/3G
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The Independent Online

House price inflation is continuing to confound all expert predictions of a pronounced slowdown or crash. Yesterday, Nationwide became the latest forecaster to admit that once again it has been too cautious. Britain's biggest building society is raising its forecast of house price inflation this year from 9 per cent to 15 per cent. Since the start of the year, house prices have taken off like a rocket, with previously affordable areas like Wales and the North of England showing year on year increases of more than 30 per cent. Even in always expensive London, prices are again rising strongly.

House price inflation is continuing to confound all expert predictions of a pronounced slowdown or crash. Yesterday, Nationwide became the latest forecaster to admit that once again it has been too cautious. Britain's biggest building society is raising its forecast of house price inflation this year from 9 per cent to 15 per cent. Since the start of the year, house prices have taken off like a rocket, with previously affordable areas like Wales and the North of England showing year on year increases of more than 30 per cent. Even in always expensive London, prices are again rising strongly.

The longer the house price bubble keeps inflating, the more likely it is to end badly. With house prices now at a record 5.3 times average earnings, higher relative to earnings than they have ever been at any point in British history, the chances of that happening are starting to look dangerously high. In its search for a reassuring explanation, Nationwide adds the thought that since people these days spend a smaller proportion of their earnings on the big ticket items of the past - food, drink, heating, clothing, tobacco and the like - there's a lot more money left over for housing.

Good point, but for the fact that there is a legion of other things people also like to spend their "extra" money on, from foreign holidays to mobile phones, computers, video games, cafe lattes and Sunday night massages. You soon find that there's not much left for housing, so you stick it on the mortgage instead.

The Bank of England would rather not raise interest rates again right now if it could possibly avoid it. Jean-Claude Trichet, chairman of the European Central Bank, gave his strongest hint yet last week that eurozone interest rates would be cut at tomorrow's meeting of the governing council. To have UK interest rates rising at a time when eurozone rates are falling will only add to the pound's strength, making the imbalance in the UK economy between still strong consumer demand and depressed manufacturing bigger still.

Indeed, there is no other immediate reason for raising interest rates other than to address the effect on overall demand of the fast inflating housing market. For at least 18 months, the Bank of England has been assuming in its Inflation Reports that house price inflation will abate to zero over a two-year timeframe. It hasn't happened so far and the evidence of recent data is that it's not going to happen this time either without further corrective interest rate action.

A quarter-point rise after next week's meeting of the Monetary Policy Committee is already priced into expectations, so to have much effect on sentiment, the Bank would need to go further. Yet if policy were to become too draconian, it would risk triggering the very housing market crash, with accompanying demand shock, the Bank wishes to avoid. The Bank must therefore raise interest rates only gradually and hope that it doesn't have too much of an effect on the exchange rate.

Interest rates are a quite crude tool with which to address the housing market. One alternative approach might have been to restrict mortgage lending, either by imposing capital constraints on banks and building societies in the manner of the old corset, or through a legally enforced limit on loan to book values, as is the case in Honk Kong.

Yet it's really far too late for alternatives. By the time the requisite consultations and legal changes have been made, the world will have moved on and the housing bubble will either have gently deflated or ended in some ghastly nemesis. The same is true of the Kate Barker report on housing supply. It will be some years before its recommended measures fully address the present imbalance between supply and demand, even if the Government decides to implement them.

It's pointless trying to predict exactly when the housing bubble will come to an end, yet one or two observations might be ventured none the less. Rapidly rising house prices are crucially dependent on the present low interest rate environment, which makes the servicing costs of large amounts of debt much more affordable than they used to be.

Lots of cheap, easily available money is the feeding stock of any asset price bubble. If money is cheap, it will always follow the herd into whatever the speculative fashion of the moment happens to be. At some stage, possibly quite soon, the US economy will turn on a sixpence. When it does, monetary conditions are bound to be made a lot tougher again. No one yet knows how tough, yet I suspect the "experts" are being too sanguine in their forecasts of continued, very low rates of inflation. The world over, monetary conditions have been looser for longer than at any stage in post-war history. Nobody yet knows what the long-term consequences of this experiment in demand management might be.

What we do know is that in the UK it has produced a house price bubble of mind blowing proportions. HBOS recently calculated that the value of the UK's housing stock has doubled over the past five years to £3 trillion. In the same period, nominal GDP has risen only 28 per cent. You can rationalise the boom in property values as much as you like, but the mismatch speaks for itself.

Hutchison/3G

Li Ka-Shing, chairman of Hutchison Whampoa, shows no sign of losing his nerve in the multi-billion pound bet he's made on 3G mobile telecommunications in Europe and Australia. If the amount of TV advertising he's throwing at 3 in the UK right now is any guide, he must if anything be turning up the taps still higher. Yet even for a company as cash rich as Hutchison there have to be limits. Mr Li's latest plan is to raise money for the struggling 3G operations by floating off a minority holding in a hotch potch of his other telecommunications interests.

The 3G endeavour has sorely tested the stock market's faith in Mr Li's legendary money-making abilities, so the IPO may be something of a defining moment for the Hong Kong-based financier. Will investors flock to the offering, as they have in the past to anything Mr Li has decided to float, or will they shun him for his apparent misjudgment over 3G?

There's a view that Mr Li and his trusted lieutenant, Canning Fok Kin Ning, have lost their touch. In recent months, they've made headway in their quest to persuade the City that 3 can eventually be made to produce a return, but scepticism remains the order of the day, and to many the billions they've invested in the enterprise looks like money down the drain. Worse, the dogged determination with which they have stuck with an enterprise which has yet to deliver anywhere near what it promises, looks uncomfortably like fool hardy bravado. To give up now would be a terrible loss of face, but how can 3 ever be worth what Hutchison is spending on it?

If there is a rational explanation for what Mr Li is doing it is the huge success he achieved with Orange. In its early years, nobody thought Orange would work either, but by investing heavily in state-of-the-art technology and marketing, Orange eventually outmanoeuvred the incumbents and became worth billions. Mr Li still believes he can repeat the trick with 3G. Calculated risk taker that he is, he would also have figured that having made so much money with Orange, it was worth the gamble to put half of it back on the tables on the off chance he'd come up trumps again.

Regrettably, it's looking a lot tougher this time around. The glory years of mobile telephony are very probably over, and the valuations that ruled when Orange was sold, first to Mannesmann and then to France Telecom, were never any more than fantasy. There may eventually be a decent business of some sort in 3, but it's going to cost billions more on top of the billions already spent to get there, and the chances of flipping it for a massive profit, in the same way as Hutchison flipped Orange, are about zero.

jeremy.warner@independent.co.uk

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