It is Obvious

Chris Rick has got altogether too much to say

This is interesting

Posted by chrisrick13 on January 14, 2011

It is obvious: I know little about economics.

The excellent website Notayesmanseconomics thundered in today on inflation.  He has been warning for a long time about inflation being a problem.  He has pointed out the moves in various futures contracts (which I don’t understand) that indicates that the financial markets (which I will carefully avoid having to define) have factored in an interest rate rise.

This is a problem for the UK.  There will come a point where the MPC cannot ignore inflation.  It seems to me that there is only one way to combat it and that is to raise interest rates.  This slows consumer led inflation and I assume that the consequent rise in the value of the pound will help with import led inflation.  Alas this is not the case if everyone else puts interest rates up.  I will carefully ignore the effect on export performance from increased interest rates and increases in the value of the pound.

If interest rates go up then I will be happy as my cash might start to retain its value under inflation.  Anyone with debts will be unhappy.  That implies a lot of people will not be able to service their mortgages.  This is mitigatged by many people having fixed rates for a number of years.  So any effect might be delayed.

This will be the big effect.  No small trigger.  If the cost of a mortgage rises to the long term average then house prices will fall to the long term average.  Versus salaries that average is 4 times and currently it is over 5 times.  House prices will drop 20% on that basis.  I will play silly games here, but suppose that the average salary of those with a mortgage drops by more than that due to some of them not having a job or moving to part time or lower paid work.  This might push the average mortgage back up to 5 times earnings.   So after the first 20% fall there might be another 20%.

I’m a pessimist so don’t listen to me.  If I put on my optimists grin can I see anything out there that is good enough news to make house prices increase?  Over the next year?  Over the next two years?  Don’t forget that interest rate rises are coming alongside the job cuts.  If you are thinking of buying wait if you can.  It will be clearer in a year and the money you have will go a lot further.

I also think it unlikely that there will be big drops.  There is too much working to counteract the cliff-edge effect.  What will happen is that homeowners will be ground down over a long period…but at nearly 5% inflation it is not that long, as, in real terms, the price of an average house has dropped by about £12,000 over the last year.  Roll in the rule of 70.  At last years rates the value of a house halves in under 10 years.  You need to be looking at that all the time.

To any first time buyer I would say: make sure you can afford the mortgage at 10 times the base rate, make sure that you have good prospects of retaining your job, be very sure that the house is somewhere that you would be happy to live for the next five to ten years.

Notayesman finishes today’s article with a good question.  The 0.5% interest rate was an emergency measure…introduced 22 months ago, so are we still in an emergency after all this time?  I would like to add my own: if we are in an emergency what has been done about it over that period?  If anyone feels equipped to answer I might then ask when will we see the results of that action.

It is obvious: I know little about economics and in common with a lot of people I seem to have a better grasp on reality than those who do know a lot and are in charge.

One Response to “This is interesting”

  1. Bill said

    I agree with your conclusions although I have some issues with the way you got there.

    In this banking crisis the banks (to make money and increase capital) have widened the gap between saving and borrowing rates. Thus the increase (percentage-wise) caused by an increase in the interest rate hike will not be as savage as expected for home-owners. Some buyers have used the time of silly rates to pay off part, at least, of their debt. What will impact house prices will be if the gov. keeps on the plan to cap housing benefit. As this fuels as high proportion of the rental market one would expect there to be a sizable impact on house prices.

    I’m not sure if the cut in gov departments will have a long-term effect on the unemployment rate. In the short term the gov sector will shed jobs which will (hopefully) be taken up by the private sector. I don’t think it will happen immediately but I think (or rather hope) that it in the longer term (2-3 years), as these private-sector jobs generate wealth (or net income to the UK in part) then this should help us turn the corner.

    The questions are really if the gov can hold its nerve. It’s not looking that good at the moment and the need to keep the liberals ‘on side’ will make it all the more difficult. The tests are:-
    Can the really cut the state benefit bill?
    Will department cuts cull administration/management or fall on the frontline workers?
    Can they keep wage rises and inflation under control?

    As a side note: My opinion is that the Bank of England’s strategy is to say all the right words about inflation but really allow it to continue at high (but not exceptional) levels for as long as possible – thus shrinking our state debts as the pound continues to slide against the eastern currency.

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