Bank underplayed risk of housing crash

The Bank of England yesterday admitted it might have underestimated the risk that raising interest rates could trigger a slump in house prices and consumer spending.

The Bank of England yesterday admitted it might have underestimated the risk that raising interest rates could trigger a slump in house prices and consumer spending.

Its Monetary Policy Committee said the downside risks - that the economy might worsen rather than improve - had increased in the last month.

The negative tone of its comments, revealed in the minutes of its meeting two weeks ago, sparked a fall in the pound as prospects of another rate rise this year receded.

The nine members of the MPC voted to keep the base rate at 4.75 per cent, the seventh unanimous vote in the past eight meetings. "It seemed that the pace of UK growth in the third quarter might be a little slower than had been envisaged, although it was too soon to judge with any certainty at this stage," they said.

The members said the recent data on the labour market, which showed static wage growth and a fall in employment, had been "surprisingly weak". "Some downside risks had perhaps increased," they said. "Further signs that the housing market was cooling might mean a greater risk of a more abrupt correction to house prices inflation. The committee may have underestimated the potential for an associated downward impact on consumption."

Sterling fell a third of a cent against the dollar and slipped back towards a seven-month low on the euro, while gilt prices - which move in the opposite direction to interest rates - rose.

"A move at next month's meeting looks unlikely," Philip Shaw, an economist at Investec, said. "The real debate is now centred on whether the MPC will tighten policy in November." But he said it would need to raise rates again next year, a view supported by most other economists who see the next rise in November or February.

The minutes show the MPC debated the need for a rate rise, citing above-trend growth, lack of spare capacity in the economy and the threat that the weaker pound would trigger inflation. But the committee decided unanimously that the arguments were insufficient to justify a rate rise. "Medium-term inflation expectations appeared to remain well anchored to the target," they said.

John Butler, UK economist at HSBC, said the markets had overlooked the "hawkish" tone of the minutes. "The new news was that some of the MPC still wanted to discuss an immediate rate hike," he said.

Meanwhile the European Central Bank said the eurozone's economic recovery was slowly broadening and that it stood ready to raise rates to tackle any inflationary pressure. Jean-Claude Trichet, its president, told the European Parliament: "The governing council is still very vigilant about any development which might involve risks to price stability in the short, medium term."