While the FED and the BoJ are still injecting “funny” money into their respective economies and certain of the European countries are urging the ECB to engage in “unsterilized” monetary easing, the BOE, under the control of Canadian Mark Carney, is preparing the ground for the next stage of the economic cycle. After nearly 6 years of interest rates at near 300 year lows, the venerable “Old Lady” is planning to lift the base rate from the current 0.5%. Anybody who has not taken the opportunity to pay down debt over the last 6 years, certainly during recent months and, if carrying a mortgage, not fixing it, is either mad or plain stupid.
Unlike the ECB, which has, largely under the direction of the Germans, not pushed the envelope on super loose monetary policy, the BOE has taken bold action from the beginning. In our opinion too bold action in keeping rates low for so long. The time to raise them was arguably 2 years ago before the nonsense that is the London property market continued to spiral ever higher. What is unequivocal now though is that the interest rate cycle has turned and that these interest rates are likely to come sooner than many have been expecting, something this publication flagged right at the beginning of the year and that goes a long way to explain the strength of the pound against its major trading peers this year.
BoE Governor Mark Carney
When Mark Carney arrived at the BoE last year, it was firmly with the impression that he was a “dove” given his actions at the Canadian Central bank and also the immediate implementation of “forward guidance” (which would immediately haunt him…). What many failed to realise however was that his actions in Canada were required under a different set of economic circumstances than those which he inherited at the BoE. He was able to keep rates lower than they would otherwise have been due to the tepid economic conditions on our doorstep in Europe and the fallacy of low inflation (does anyone else think that the inflation figures pumped out by the Government bear any relation to what we actually see on the ground?!). If interest rates remain lower for much longer in the UK then he risks igniting a serious housing boom as the London effect ripples out (which it is wont to do and has done on almost every occasion in the past) to the provinces and ultimately the peak of this cycle would be much higher than it should be as they try to brake a likely resurgence in inflation.
Banks have in fact been relaxing wider conditions for credit notwithstanding the BoE’s attempts to impose onerous “affordability” tests on borrowers. Indeed, 4 times salary mortgages and for periods that could go up to 45 years are becoming more common as the underlying house prices have become so detached from average earnings (a warning sign in itself). In the end, such loans represent a massive use of leverage, and which means that under a deterioration of economic conditions, those borrowers could run into deep trouble…
Carney recently made various comments expressing his concern about the level of mortgage debt currently outstanding, stating that when interest rates start rising again, some households will no doubt have difficulties paying. The spectre of people being thrown out of their homes that was muted dramatically in the UK through the ZIRP policy of recent years may finally rear its ugly head.
In contrast, while the discussion in the UK is about a potential over-heating of the property market, in Spain, the housing market is still going through a bottoming process and only now starting a recovery. After six years of consecutive declines in prices and sales, there are some signs of recovery. Still, with 25% of the work force unemployed, the housing market is but a mere shadow of what it used to be and home prices are now, at the median level, a stunning 47% below their peak in 2007.
These two different realities help understand why the Euro is failing as a project. European countries are individually very heterogeneous and the last thing they need is a uniform monetary and fiscal policy. This very policy continues to destroy some of the constituent economies while the UK, in complete contrast is leading the pack out of the great recession, in large part thanks to the Great British pound!
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