Unconventional monetary policy increased house prices. Will its withdrawal spark a sell-off?

Thu 19 Jul 2018

In March the Bank of England released a working paper titled ‘The distributional impact of monetary policy easing in the UK between 2008 and 2014’. For context, quantitative easing and ultra-low interest rates have been blamed by many commentators for a rise in inequality which has fermented populism in recent years. However the paper found (perhaps unsurprisingly given the author) that the actions the Bank took actually reduced inequality rather than increasing it, with younger households benefiting from higher income and asset prices despite older households from higher wealth.

The paper concluded that without the action taken, GDP would have been 8% lower and unemployment 4% higher by 2014, with house and equity prices significantly lower. Further they calculated that richer households did not gain by more in percentage terms even when only looking at the effects on wealth, and not including wages:

However people rarely think in terms of percentages, and Bank Underground, where blogs are written to surmise the Bank’s working papers, said: “But it is worth noting that existing differences in net wealth mean that a 10% increase for all would equate to £200 for the bottom decile and £195,000 for the richest”. The chart below shows the effect of the policy massively benefitted richer households in nominal terms (again this excluding wages):

Another reason that QE might have been unpopular, especially among the retired, was that although it increased their wealth by inflating the value of pensions and housing, it reduced the level of interest/income earned on assets, so that many felt that lower interest rates hadn’t benefitted them:

Even though they were on the whole better off once the wealth effect is included:

We are now in a situation where the Bank of England is preparing to reverse some of these policies. An interest rate rise is expected at some point this year (although the fluid situation regarding Brexit continues to cause uncertainty here), so could all this wealth created by unconventional monetary policy now be destroyed? Perhaps, but it should be remembered that the loosening of policy and injection of liquidity was quite sudden, while its reversal may take decades to play out. Indeed the Bank of England doesn’t have a target for when the assets bought as part of the QE programme should be removed from its balance sheet, and since the 1990s interest rate rises have tended to be more gradual than interest rate cuts, while reaching lower and lower peaks. Before the 1990s interest rate rising cycles were often quite sudden.

Examining the chart below, prior to the GFC it can be argued that house prices (in grey) led UK interest rates (in blue), and not the other way around. This makes sense since a booming economy, and hence house price pressure, forced interest rate rises to prevent inflation getting out of hand, while a slowing economy and falling house prices were met by cuts to interest rates. There was some interdependence here, since interest rates rising too high curbs growth and thus house prices, so that inordinately high interest rates are likely to affect house prices going forwards. However since the GFC interest rates have remained historically low, with interest rates needing to increase an awful lot before they get to the kind of levels where they perhaps affected house prices in the past.

According to the Nationwide Building Society the average mortgage is £125,000 (as of September 2017), so that a 0.25% rate rise would increase interest payments by just £15 per month. Further 57% of borrowers are on fixed-rate deals, so wouldn’t be immediately impacted. Longer term the effects will increase as people have to re-mortgage at higher rates, but for the time being interest rates are likely to have a minimal effect on house purchasing demand. Given the length of the cycle and uncertain political environment it is much more likely that a factor other than a few interest rate rises will cause the next economic downturn, and the next fall in house prices.