How can the Bank of England prick the house price bubble?

Amid fears of another house price boom, we look at what Mark Carney can do if he won't raise interest rates

Bank of England governor Mark Carney has vowed to curb another property bubble in the UK using a "tool kit" of powers to prevent reckless lending. But amid fears that the government's Help to Buy scheme, combined with ultra-low interest rates, will spark another surge in house prices, what can Carney really do to clamp down on a fresh boom?

Figures from Nationwide Building Society confirmed that Britain's property market is stoking up once again. Prices rose by 0.6% in August 2013, the eleventh consecutive monthly increase, and are now growing at an annualised rate of around 6%.

Traditionally, Bank of England governors have used interest rate rises to quell inflationary pressures. But Carney, in his "forward guidance", has said he won't raise interest rates until the unemployment rate has fallen to 7% or below. Given that current unemployment is around 7.8% and falling only slowly, most economists have seen this as an indication that interest rates won't rise until mid-2015.

So what could Carney do if he can't raise interest rates?

Maybe he'll follow the example of New Zealand. Median house prices have jumped by 8.6% over the past year in that country, which was enough for central bank governor Graeme Wheeler to step in a fortnight ago and order the banks to stop granting low-deposit loans from this October. In a harsher-than-expected move, buyers will find it much tougher to obtain a mortgage unless they have at least a 20% deposit. The way the governor has done it in New Zealand is to restrict loans above 80% to no more than one-tenth of all a bank's mortgage lending.

Carney is no stranger to this sort of intervention in the housing market. As governor of Canada's central bank, he cooperated with the finance minister (equal to the chancellor in the UK) to cut repayment periods and cap the total amount that borrowers could pay as a proportion of their income. Canadians had become accustomed to spreading out their mortgages over 35 or even 40 years, keeping costs low but enabling buyers to take out jumbo-sized loans. But this was pushed back down to 25 years, while the banks were told that no one buying a home could pay more than 39% of their income as a repayment.

Does Carney have the power to do that here?

Yes and no. The Bank of England's new Financial Policy Committee, part of the post-crisis regime introduced by George Osborne, has been given the job of spotting future bubbles. If it believes the housing market is overheating, it can direct the banking regulator, the new Prudential Regulatory Authority (PRA – also, confusingly, an arm of the Bank), to tighten the screw on mortgage lenders.

But instead of acting directly, for example to constrain what multiple of their income homebuyers could borrow, the PRA would use so-called sectoral capital requirements to give banks pause for thought before they make risky loans. They could force the lenders to set aside more capital against all residential property lending, for example, if they thought the entire market was frothy — or pick on particular areas, such as high loan-to-value ratio mortgages. In practice, whichever types of loan the PRA singled out would become scarcer and more expensive.

Does this mean first-time buyers would go to the back of the queue?

Yes. The housing market was paralysed after the credit crunch as cash-starved banks pulled out of 90%-plus loans, but they continued to offer low-cost mortgages to those with at least 25% equity in their homes. What is likely is that 90% loans would still be available, but they would be priced high to reflect the cost to the banks of offering them, and so would not be affordable for the vast majority of first-time buyers.

Would there be a way around the rules?

Possibly. One argument against capital controls is that if buyers are forced to take out no more than, say, an 80% loan, they will simply go elsewhere to top it up with a separate (and pricier) personal loan and other debt. It could be a boon for secondary lenders able to sidestep the controls on high street players. But even if this did happen, the overall cost of borrowing would rise, so it would prevent many buyers from competing for property.

Will the buy-to-let brigade still soldier on?

For regulatory purposes, buy-to-let is treated separately to standard residential lending and doesn't come under the same rules. But if there were signs that buy-to-let was driving a housing boom, Carney could still force banks to hold more capital against that category of lending, which would make it more costly.

What actually constitutes a house price boom?

This is finger-in-the-air time. New Zealand's move came when price rises moved above 8%. In the London market (itself a multiple of the entire New Zealand market) house price rises are already up 10.2% over the past year, according to the latest figures from property portal Yet in the north, north-west, Yorkshire and Humberside and south-west regions, house prices are up less than 1% over the past year.

The Bank has said it will monitor a range of indicators, including average loan to value and loan to income ratios for mortgages, and the level of household debt, in order to assess whether a boom is underway.

So if I live in Newcastle, I could be prevented from getting a mortgage because of what's happening in London?

Spot on. Lending controls are a blunt instrument. If the price spiral in London becomes so severe that Carney intervenes, then the victims will be nationwide, not only in the capital. Houses in Newcastle could represent good value and be affordable to first-time buyers, but lenders would be constrained from granting loans. Carney won't be able to dictate that lenders stop lending in Hackney, but carry on lending in Hartlepool.

Why didn't the Bank of England step in to stop the last property bubble?

Well for one thing, economists are never great at spotting a bubble until after it has burst, and while Lord King did warn that house prices could not keep rising so fast for ever, the Bank was never concerned enough to act. But before the crisis, the only lever the monetary policy committee could pull was the interest rate; and a rate rise large enough to pop the property bubble might have clobbered the rest of the economy. Next time around, they'll have new tools at their disposal.

I'm a saver rather than a borrower. Is this more bad news for me?

Yes. Carney appears determined to find instruments other than interest rate rises to intervene in the economy. The message is that your cash Isa or deposit account is going to continue to pay paltry interest for years to come.

So is Carney really in charge of the economy, not George Osborne?

Good question: Gordon Brown made the Bank of England independent, because he believed that setting interest rates was a technical, economic decision that could be separated from politics. But some of the drastic decisions the Bank has been involved in since the onset of the crisis, on quantitative easing, for example, have strayed much closer to the traditional tax-and-spending decisions of governments. It's not impossible that at some future date, a chancellor could take action to stimulate the economy – through tax cuts, for example – at just the same time as a more cautious Bank governor is slamming on the brakes. © 2013 Guardian News and Media Limited or its affiliated companies. All rights reserved. | Use of this content is subject to our Terms & Conditions | More Feeds

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