Posted on 14-5-2004
Bank Warning - UK
by Larry Elliot, May 13, 2004, The Guardian
Labour may be forced to fight the next general election against
a backdrop
of higher interest rates, rising inflation and a rapidly cooling
housing
market, the Bank of England warned yesterday.
In its quarterly health check of the economy, the Bank dropped
the
broadest of hints that further increases in the cost of borrowing
were in
the pipeline following last week's rise to 4.25%.
The Bank is forecasting that inflation will gradually pick up
in 2005,
even though the economy, and the property market in particular,
will be
slowing. June of next year is seen as the likeliest timing for
polling
day, and the government plans to make the strength of the economy
the
centrepiece of its campaign for a third term.
Last night the City was pencilling in rates of about 5% by the
summer of
next year in response to hawkish comments from the Bank explaining
why it
raised rates despite inflation being well below its 2% target.
Mervyn King, the Bank's governor, told a press conference: "The
view that
the market has been taking lately - that further increases in
interest
rates may be necessary - is not an unreasonable one."
The Bank's two-year forecasts in its inflation report predicted
that
growth would remain robust in the short term but then start
to ease back.
"Overall, the outlook for GDP growth is stronger than expected
in the
first year of the projection, but weaker thereafter."
It added that the change in its view since the last inflation
report in
February had been affected in part by movements in the housing
market.
The projection from the Bank's monetary policy committee is
"for house
price inflation to slow sharply during the next two years, though
house
prices may well continue to rise strongly in the near term".
The Bank stressed that the ratio of house prices to earnings
was above a
sustainable level, even accounting for a background of lower
inflation and
cheaper borrowing costs.
"Although there are several reasons to suppose that the
ratio of house
prices to earnings might remain higher than in the past, it
is hard to
believe that they can account for the full extent of its recent
rise. At
some stage, therefore, house prices are likely to rise more
slowly than
earnings."
Latest figures from Nationwide and the Halifax suggest house
price
inflation is running at almost 20%, though data collected by
the Office of
the Deputy Prime Minister point to a much lower rate of growth
of just
under 8%. Average earnings are rising at an annual rate of just
over 5%.
The report predicted a rise in the cost of servicing debts as
interest
rate increases start to bite. Over the next two years, the Bank
believes
debt servicing costs may rise to "levels last seen in the
early 1990s, but
not necessarily the level of the previous peak in 1990".
Mr King said the lower level of rates compared to the 80s meant
borrowers
were less vulnerable now; rates would have to hit 9% for borrowers
to face
as big a problem as they did 15 years ago.
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