The driving forces
Rising house prices, he explains, affect the way people act and the decisions they make. For example, in a rapidly rising market, buyers will look to get in as soon as possible for fear of being priced out. Sellers, on the other hand will tend to ask for higher prices and ultimately people will be more willing to get into debt to move up the housing ladder. He continues, “It is difficult to know how much expectations are driving the current market. But there is good reason to believe that a mutually reinforcing combination of strong demand, weak supply and expectations of a rising market could lead to a period of sustained and very powerful pressure on house prices in the UK.” Whether it poses a threat to financial stability, however, depends on whether that pressure leads to more transactions at higher prices and then to greater household debt and whether that is concentrated.
He is also concerned that the current low interest rates could mask the true cost of mortgages, thus pushing prices up even further.
He concedes that the new MMR rules in themselves may be helping to slow things down in the market and are likely to continue to do so, but remain as yet untested. He says that the direct exposure of the financial system to the housing market and its resilience to a major housing shock must be at the forefront since mortgage lending constitutes two thirds of UK banks’ and building societies’ lending. To determine the system’s strength, eight UK lenders will be stress-tested this year based on the effects of a steep drop in house prices.
The withdrawal of funding for lending from the mortgage market in February was one of the first responses to the momentum in the market. The challenge for the FPC, however, is to determine whether it needs to take any further action – and if so, what – if momentum fails to dampen sufficiently. As Cunliffe says, the FPC will need to be vigilant and ready to act if it is to avoid what he refers to as “a movie that has been seen more than once in the UK.”