Rates `must reach 10% to level house price inflation'

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Interest rates will need to climb to 10 per cent in order to level off house price inflation to an acceptable level, according to research published this morning. The prediction comes amid further evidence of a consumer boom at home and mounting problems for the country's exporters.

Douglas McWilliams, of the Centre for Economics and Business Research, said: "If we have to rely on interest rates alone to level off house price inflation, they will need to climb to 10 per cent." He predicted that the Budget measures to halt booming prices - a reduction in mortgage interest tax relief (Miras) and an increase in stamp duty on sales worth more than pounds 250,000 - would have almost no effect on the housing market.

The survey was backed up by research from Dun & Bradstreet, which showed more than half Britain's senior managers expected interest rates to rise above 7 per cent by the end of the year. A third expected a base rate of 7.5 per cent as growing numbers of retailers forecast increasing sales and higher prices over the next three months.

Professor McWilliams predicted the next Budget would abolish Miras, increase stamp duty further and increase council tax in order to nip the housing boom in the bud.

The CEBR calculated that Gordon Brown's recent measures would slice a mere pounds 88 off average house prices, currently rising at a rate of pounds 7,000 a year. By contrast, the Bank of England's decision to raise interest rates by a quarter point last week would trim the increase by pounds 228.

After the Bank's announcement, Abbey National and Cheltenham & Gloucester increased their variable mortgage rates by a quarter point, adding more than pounds 7 to the monthly repayment on an average pounds 50,000 loan. Others, including Halifax and Nationwide, are considering whether to follow suit.

Professor McWilliams said: "House price inflation will have to be levelled off somehow. The problem with using interest rates as the main weapon is that the exporting sector and the corporate sector in general suffer collateral damage from a strong pound."

The pound rose above DM3 last Friday as some currency experts said sterling was more overvalued than at any time since the Conservative squeeze on the manufacturing sector in the early 1980s. An analysis by BZW suggests the pound is as overpriced now as it was shortly after the election of Margaret Thatcher in 1979, when it had a devastating impact on industry.

With some analysts believing the pound could be between 15 and 20 per cent overvalued against the mark and the dollar, Goldman Sachs is understood to have started advising its clients to sell sterling. The American bank has predicted a fall to DM2.40 over the next year.

According to Dun & Bradstreet, the manufacturing sector is more pessimistic than at any time since 1991. Only 55 per cent expect an increase in exports over the next three months and they are forecasting lower prices as a result.

Not all experts agree with Professor McWilliams' prediction. Professor David Miles, of Imperial College, said: "We could get to house price inflation of above 10 per cent without having to worry about bubbles and frenzy. The Government and Bank of England should not start panicking yet."

The deep slump in the market meant prices were about 10 to 15 per cent undervalued in real terms, he said. In addition, the long-run trend was for house price inflation to exceed the general inflation level because of the fact that land was in fixed supply.

However, the Chancellor introduced the Budget changes as a bid to calm the housing market. In his speech he said: "I will not allow house prices to get out of control and put at risk the sustainability of the recovery."

But economists agree the tax changes will have had little impact. Simon Briscoe, chief economist at Nikko Europe, said: "It was right to increase stamp duty on higher-priced properties. But the Budget measures were so feeble they were not worth bothering about."

He argued that the reduction in Miras would hit average households, where house price inflation was not a danger, and do nothing to skim the froth off the top end of the housing market.

"There are two very separate housing markets - the South-east and the rest. The Budget is not going to affect the international businessman on a six-figure salary," he said.

Recent regional house price figures from Halifax confirmed this pattern. Annual house price inflation for the UK as a whole was 7.1 per cent in the year to June. But the annual rate of increase in Greater London was 16.1 per cent, compared with 2.3 per cent in the North and no change in Scotland.