Tuesday, 17 July 2007

Hammer and anvil

Today, the UK economy and its housing market, received two pieces of bad news. The first was on inflation; the second was on the exchange rate.

Although the the CPI inflation rate appeared to edge downward slightly in June, the much more reliable RPI measure was definitely heading north. In June, the RPI rate was 4.4 percent. Moreover, core inflation, a bogus but presentationally important indicator also crossed over the line. It is now at its most elevated level since the Bank started publishing this quasi-fraudulent index.

Unfortunately, core inflation disappointed the Bank of England. Normally, the role of core inflation is to confuse people about the true extent of inflation. In the past, the RPI inflation rate might have been powering upwards, but core inflation, which excludes marginal items like food and fuel, could be relied to stay firmly anchored just slightly above 1 percent. Not so, this month.

Here is the problem for the Bank in a nutshell. For a variety of reasons, food prices are rising worldwide. Key commodities are definitely getting pricier. Everyone knows it, including the Bank of England. Likewise, fuel prices are likely to go up. OPEC are talking of cutting production quotas, and the $90 barrel of oil is only a matter of a few weeks away. Now, core inflation is accelerating. It all makes grim reading for the MPC. Looking forward, even the dim-witted MPC can see that there is wave of inflation is about to crash over their heads.

There is only one course of action. Once everyone gets back, nicely tanned from the summer holidays, the Bank will ring in Winter with another hike in interest rates. It could come in September, but it is more likely in October.

All this talk of higher interest rates is destabilising the pound. It is now at a 26 year high against the dollar, and it could go higher. At the moment, the pound is perhaps, 25 to 30 percent overvalued. This will inevitably put the exports under some pressure, and if the overvaluation persists, it may even cause a recession.

What does all this mean for the UK's bloated housing market. Higher interest rates mean higher mortgage payments, declining demand and more repossessions. While house prices might fall in terms of pounds, the higher exchange rate will keep UK house prices high in terms of dollars. Many of those foreigners, particular from Russia and the middle east, tend to price things in dollars. When considering London, they will be faced with a strange convolution of effects; a declining housing market that is actually appreciating in the currency that denominates the bulk of their wealth. Only the really stupid homebuyer would enter that kind of market.

So, taken together, the UK housing market sits between the hammer of higher interest rates and the anvil of an overvalued and appreciating exchange rate.


Riccardo Tonelli said...

Interest rates will go up again.

The historical average is 8.74%. We will reach and exceed that soon.

Kevin said...


sb322 said...
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