House price boom crushes hopes of cut in rates

A cut in interest rates is almost certainly off the agenda for the foreseeable future because of fears that it would fuel the unsustainable boom in house prices, the Bank of England indicated yesterday.

In its latest quarterly inflation report, the Bank said it now judged the risks to be on the upside and forecast that inflation would remain above the targeted rate of 2.5 per cent for most of next year because of higher property and oil prices.

The surge in house prices last month, when the annual increase hit 25 to 30 per cent, took the Bank by surprise and was one of the key factors behind the Monetary Policy Committee's decision to keep interest rates at 4 per cent when it met last week.

But Mervyn King, the Bank's deputy governor, also highlighted the "tremendous uncertainties in both directions" for inflation and growth as an important influence. Apart from soaring house prices, other risks clouding the outlook included the prospect of US consumer spending faltering, eurozone growth remaining sluggish and next spring's increase in national insurance contributions feeding through into higher wages and prices.

The central projection in the Bank's inflation forecast is that the rise in house prices will slow down over the next two years and come to a standstill by the end of the period.

But Mr King admitted this was largely based on a belief that house prices could not keep rising at the rate they have been. "The honest answer is that no one knows what is likely to happen to house prices," he added.

The Bank is concerned that the longer the house price boom continues, the more abrupt will be the slowdown when the property market finally comes off the boil.

While the risk to inflation was slightly on the upside, the risk to growth was "weighted somewhat to the downside", the Bank said. In those circumstances the MPC stood ready to take whatever "prompt action might be required if any of those risks appeared to be crystallising".

Analysts said that in the absence of a sudden shock to the economy, the outlook was for stable interest rates in the near term. "We place a relatively low probability on an interest rate cut at the December MPC meeting," said Alan Castle, an economist at Lehman Brothers.

The likelihood of an early cut in rates was further reduced by Government figures showing that unemployment fell last month to a fresh 27-year low. The Office for National Statistics said that the number of people out of work and claiming benefit in October fell by 4,500 to 940,500 – the lowest since October 1975 – producing a jobless rate of 3.1 per cent.

However, officials cautioned that the underlying trend in unemployment was up, using the Government's preferred Labour Force Survey that includes those who are no longer in work but not claiming benefit either. This rose by 45,000 in the three months to the end of September to hit a near two-year high of 1,541,000.