MPC member plays down fears of housing meltdown

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The Independent Online

Interest rates would have to surge to almost three times their current level before households faced the same debt burden costs they did during the 1980s housing boom, a Bank of England policymaker said yesterday.

Sushil Wadhwani, an external member of the Monetary Policy Committee, said that the risks that unsustainable debt levels could trigger an economic shock were "overstated".

"In order for the debt servicing ratio to return to the peak seen in the early 1990s ... interest rates would need to increase to almost 11 per cent," he said. The base rate stands at 4 per cent.

"Of course, it is possible to envisage circumstances where rates might need to rise considerably but in my personal view the rise in the debt-to-income ratio should make us more cautious about doing so."

Dr Wadhwani also used his speech to urge the Bank not to keep rates higher than needed just to insure against an inflation shock that might never materialise.

He told the Macclesfield Chamber of Commerce that rates should not be kept high because of a fear that a collapse in the pound – which could be triggered by a further increase in consumer debt – would lead to a surge in inflation.

He said this could exacerbate imbalances in the economy by actually causing sterling to appreciate and undermining corporate balance sheets.

"The desire to reduce inflation by holding rates higher today could actually result in an increase in future inflation volatility," he said.

His argument against a bias towards higher rates was boosted by a separate report claiming that rates stayed too high for too long because the MPC over-estimated inflation by 0.2 percentage points during its four-year life.

"The demons the MPC thought they saw did not materialise," Professor Ken Wallis of Warwick University told the Royal Economic Society conference.

"These are early days, the numbers are small and the MPC is still learning, but these mistakes have costs. More accurate probabilities would have made earlier reductions in rates more likely."

He declined to say which decisions were wrong. The MPC twice embarked on a major rate-cutting programme, in the summer of 1998 and through last year.

"The overall message is that they were biased upwards and they exhibited more uncertainty than seemed to be justified by the evidence and they were too scared of shocks that never materialised," Professor Wallis said.

He said the MPC should have "listened sooner than they did" to the pleas for rate cuts made by DeAnne Julius and Dr Wadhwani.

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