Tuesday, Dec 19, 2006

Govt interfering in interest rate decisions

IFA online: Treasury's 'over-optimistic' forecasts hinder MPC

The House of Lords have criticised the Treasury for producing over-optimistic forecasts which is making it more difficult than it needs to be for the Bank of England to set interest rates.

A report published today by the House of Lords Economic Affairs Committee, also recommends the Bank of England should carry out more research into the link between rising house prices and consumer spending.

Posted by little professor @ 09:07 AM (571 views)
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1. paul said...

Interesting comment:

"Mervyn King, governor of the Bank of England, told the Committee in his evidence for the report, that while the MPC considers house prices when assessing the outlook for inflation it does not try to influence them"

simply doesn't ring true. Had that been the case, the MPC would have raised rates to meet the true cost of inflation (from rising house prices) during recent years.

They didn't and by doing so, influenced house prices. Interesting therefore for them to come forward now saying that's not what they do.

In fact downright hypocritical.

Tuesday, December 19, 2006 11:15AM Report Comment

2. monty said...

It was Nohpc who pointed out the problem with including housing costs in your "true cost of inflation". As soon as you raise rates, you increase housing costs which increases the inflation figure and you thus have to raise rates again. Just where does it end or had you figured that one out already? :-)

Tuesday, December 19, 2006 11:34AM Report Comment

3. paul said...

Mervyn King and I are agreed on this,l even if the MPC doesn't agree.

Remember the MPC does not consist of Swervin Mervyn alone.


You can side with nohpc if you like.

Tuesday, December 19, 2006 12:08PM Report Comment

4. denzil said...

Excluding housing costs which are in most cases a persons largest outgoing from inflation figures creates and instantaneous illusion of low inflation and make the inflation waters look very calm indeed. But of course this is a fallacy because the reality of the situation is that by not including housing costs real wages soon decline relative to the true inflation witnessed by the home owner.
This problem could in some way be diluted by having much longer fixed rate deals instead the popular discounted rates which are instantly susceptable to changes in base rates and will show month to month spikes in inflation. Long-term fixed rates are not favoured by the bank due to the element of risk, a risk which is reflective in the higher rates for long-term fixed deals.

It is completely and utterly wrong to allow an individuals largest outgoing (housing) to be ignored in the inflation measure. The first is that if you have high HPI during a cycle of increasing base rates the true affect of real inflation on the house buyer is not factored in wage negotiations and you end up with the scenario of falling personal income. Which is of course great for providing downward pressure on inflation because there is less money in the economy to spend on electrical goods etc, thus suppliers price competitively for a shrinking customer base, etc.

So what can be done to make it fair? I don't personally believe that including 100% of mortgage costs into inflation figures is right. If we did go that way we would need a highly skilled chancellor to balance inflation. The chancellor would have to perform this balancing act by building a strong economy that provided both manufacturing and service sectors along with making the UK an attractive place to create business. Returning to housing costs in inflation I believe the US use a the system of including rental costs only, which in a BTL boom phase will again hold down inflation due to supply and demand of rental property. Most STR on here will probably attest to the fact that rent has not risen for years. Mervyn King recently stated that he doubted whether housing would be included in the inflation measure in his lifetime. My personal view is that the inflation measure need to be a ratio of house purchase and house rental costs with a bias towards home ownership. The thing is, to have implemented that over the last few years would have sent inflation through the roof which would not have helped the miracle economy.

In a civilised society I think it is only fair that all people of working age should have the possibility to become owner occupiers and I find it entirely farcical that the biggest asset and outgoing in anybodies lifetime is allowed to run completely independantly of any link with inflation, but if you want to make the inflation figures look relatively calm and provide a money tree (HPI) to sythetically prop up growth then it is a fantastic idea but it is only fantastic for so long because the truth will eventually prevail in that type of economy because it is built on sand.

Tuesday, December 19, 2006 12:19PM Report Comment

5. george monsoon said...

I agree Denzil.

"inflation is a rise in the general level of prices" which to my mind encompases anything that involves financial transaction.
Am I correct, or just misguided?
Like you say house prices should be included 100% I wonder what inflation figures would look like then?

Tuesday, December 19, 2006 12:30PM Report Comment

6. bidin'matime said...

It shouldn't take too long for a moderately intelligent economist with a spreadsheet to come up with a model that incorporates house prices and mortgage rates, smoothed over a suitable period to avoid sudden spikes, to reflect these in the inflation index.
My favourite extract is:-

It recommends the Bank should undertake extensive research on the link between house prices and consumer spending to establish a better understanding of the issue and to ensure the decisions of the MPC are made with the best available knowledge.

Diplomatic language for "the economy is going to rat-sh*t due to HPI and associated MEWing and you idiots are sticking your heads in the sand..."

Tuesday, December 19, 2006 01:23PM Report Comment

7. Cyril said...

I think the BoE should take the housing market into account when they set interest rates, for purely common sense reasons. Monty's argument that this would create instability is a bit odd. If you did include housing costs in inflation, it would just mean that any given change in IR would have a bigger impact than it does under the current rules.

I suppose confusion arises in people's minds because people think of housing as an investment. Because house prices are ignored for the purposes of setting interest rates, the cost of buying a house over the last few years has been zero or negative. Ideal conditions for a bubble - speculative investment in non-productive assets.

The funny thing is that, if inflation is actually higher than the official figures (which it obviously is), house prices aren't as high as they look and we are all less well off than we thought we were.

Tuesday, December 19, 2006 01:26PM Report Comment

8. Sebastian said...

Monty, or if interest rates are kept down while house prices rise out of control inflation goes up anyway...so on your logic we either have cheaper houses with higher inflation or expensive houses with higher inflation?

Tuesday, December 19, 2006 01:35PM Report Comment

9. holding out said...

I wouldn't rush to include house prices in the measure of inflation when we've just undergone a massive rise. If you want to include them you need to do it at the start of a cycle. I'm sure that if prices start heading south Gordon will be very keen to have them included.

Tuesday, December 19, 2006 01:38PM Report Comment

10. george monsoon said...


Tuesday, December 19, 2006 01:56PM Report Comment

11. Boarder said...

inflation is a fall in the purchasing power of a currency.

Tuesday, December 19, 2006 02:25PM Report Comment

12. denzil said...

holding out said:
>>I wouldn't rush to include house prices in the measure of inflation when we've just undergone a massive rise. If you want to include them you need to do it at the start of a cycle. I'm sure that if prices start heading south Gordon will be very keen to have them included.

To true my friend. I read something recently that the US are considering moving away from the current housing inflation measure of rent to purchase. Hmm I wonder why :-)

Bidin, you are right and I too cannot see why it is such a problem inventing a fair formula that would incorperate HPI into inflation measures. If HPI was included in inflation measures, the government would be more keen to ensure the right type and number of houses are being built to balance the laws of supply vs demand and thus keep inflation nice and stable. It's s cheap fudge removing HPI from the stats.

Tuesday, December 19, 2006 02:36PM Report Comment

13. monty said...

It sounds quite reasonable to include some form of HPI in the overall inflation figure but it clearly has to be done in such a way that it avoids the rate rise spiral described earlier.

Including rental costs in the index has the same problems as mortgage repayments. The recent stability of rents can quite easily be attributed to the stability of the interest rate over the last two years. There may be a lag effect but those rents will increase over the long term as the BTLers costs are passed on to renters in proportion to the rate increase.

Tuesday, December 19, 2006 03:58PM Report Comment

14. talking rot said...

Give Mervyn King his due. He has been banging his head against the European wall because of the glacial speed at which the CPI changes. I recall reading a report in either The Times or the Telegraph in which he lambasted the Euro Bank for not including accomodation costs in the CPI. He ended the interview, in exasperation, stating he no longer believed he would see housing costs appear within the CPI "in his time."

If you believe the CPI is a poor measure of inflation, blame the Europeans for deciding what it should measure and Gordon Brown for choosing it.

Tuesday, December 19, 2006 04:34PM Report Comment

15. denzil said...

Monty said:
>>There may be a lag effect but those rents will increase over the long term as the BTLers costs are passed on to renters in proportion to the rate increase.

Actually that may not occur which skews the measure even more. If my local area is indicative of the country as a whole there is no way that BTL are able to pass on the costs of the increase in IR's because there is too much choice for the renter. It's wise not to rent from a very recent BTL landlord as he has no spare capacity. I'm seeing "To Let" signs up for months on end and a friend in the letting business will admit there is no upward pressure on rents regardless of increases to base rates.

Tuesday, December 19, 2006 04:55PM Report Comment

16. Sam said...

wow, an old BTL'er in area consisting of mostly new BTL'ers could make a killing (as they would force up the rent prices in that area).

however it would be more of a freak occurance rather than trend.

Tuesday, December 19, 2006 05:07PM Report Comment

17. Randomkevlar said...

My 1 bed flat in west london costs 725 a month, when we rented it 15 months ago the agent wanted 750 but when we offered 725 saying some rubbish about council tax to justify the reduction the owner/agent agreed in a blink of an eye (should have gone for 700), this year no attempt to raise the rent was made even though IR rates had already started going up. The flat would cost around the 190,000 mark to buy, I would just like to openly thank my landlord for subsidizing my rather nice flat by the thames.

PS. the landlord has had to replace the garage door (around 700) redo the kitchen plumbing (new sink etc - around 300), repair the bathroom plumbing twice (not sure of cost but the plumber still got to do more in the new year) and buy a new oven (450), all in under 16 months, boy I love renting.

Tuesday, December 19, 2006 05:10PM Report Comment

18. bidin'matime said...

Interesting debate, isnt it - in the long term, will the cost of renting rise to reflect the true cost of owning property or will the value of property fall to reflect its true value as accommodation, as shown by rental levels?

I suspect that the answer lies somewhere in between, but in the short to medium term, my money is firmly on a fall in values. As many have pointed out, the pressure to pay more rent is simply not there. Our last place gave the landlord a yield before any costs (agents' fees, interest, insurance etc.) of around 4.2% - we were there 16 months and had to give 2 months notice (that was the end of September), but the agent has put the asking rent up by 100 and its still empty despite nearly 3 months of marketing it.

Our present house returns the landlord 3.36% before agents fees etc. (we know exactly, because he only just bought it). Slightly different here because its quite nice and he plans to retire here when he gets back from cruising the Caribbean, so you could say we are house-sitters paying for the privilege. However, the fact remains that the true value of property as a place to live is way below the cost of providing it, so eventually that must reflect in the market price for property.

Anyone who denies that this is a bubble is a fool or a liar.

Tuesday, December 19, 2006 08:21PM Report Comment

19. monty said...


Send your landlord a nice Christmas card if you're that grateful. If the "rather nice flat by the thames" in "west london" is worth 190k now, it was probably worth 20% or so less than that 16 months ago. An 85% mortgage on that at 5% would cost your exceedingly generous landlord a whopping 538 to service, leaving some change for plumbers, kitchens, agency fees etc. Putting aside the paper profit of 38k and assuming you won't be needing another kitchen/garage door/bathroom soon your benefactor will still be making 9% in years to come on his original outlay. I'm guessing he's a happy camper - I certainly would be with those numbers. It sounds like a win-win to me.

I like renting too. It's convenient and suits my lifestyle right now. My landlords get a substantial boost to their monthly income and as they own the property outright every penny is pure profit. It's all win-win here too and I've sent them a Christmas card.

Tuesday, December 19, 2006 08:36PM Report Comment

20. Ticktock said...

Ref- It sounds quite reasonable to include some form of HPI in the overall inflation figure but it clearly has to be done in such a way that it avoids the rate rise spiral described earlier

But if HPI had been taken into account during the boom there would be no need for a rate rise 'spiral', as the rises would have choked the growth off before it became a problem wouldn't it?

As Holding out suggests, I wouldn't be at all surprised if HPI was included in stats. as prices fall though.

Boarder - Indeed it is, but this can be hidden with 'floating exchange rates' (for a while) i think.

Tuesday, December 19, 2006 09:14PM Report Comment

21. bidin'matime said...

Monty - "as they own the property outright every penny is pure profit" - the point here is that the profit is lower than the profit they could get if they sold the place and invested in a good building society account.

The landlord is foregoing that interest in return for capital growth so we are back to the fact that BTL depends on HPI to be viable not a sound long term proposition, particularly starting from the current level of the market.

Tuesday, December 19, 2006 10:28PM Report Comment

22. Shanghaitim said...


Maybe he has a good building society account too? As a way of ensuring income from different directions, having a fully paid off property with someone sitting inside it paying rent is hardly stupid! Whatever happens to interest rates he'll be able to undercut the market on rent if he wants (/needs to to ensure occupancy) and at least get some pocket money to buy sweeties at the corner shop. If he's got many eggs, having some in the property basket isn't crazy, if it's debt-free.


Wednesday, December 20, 2006 04:11AM Report Comment

23. Randomkevlar said...

Thanks Monty I will pop one in the post to the landlord. But on my limited calc's worked out that a say 170000 mortage over 25 years at 5% (normal repayment mortgage) would be around the 1000 mark?

Calculate your repayments (from BBC website data)

Mortgage required 170000
Repayment period 25 years
Interest rate 5%
Monthly repayment 1005.15
(Interest only) 708.33
But be careful, at 12% it will be: 1806.24

is the BBC website wrong?

Wednesday, December 20, 2006 10:50AM Report Comment

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