Monetary policy is the manipulation by the Bank of England’s monetary policy committee of monetary variables, such as interest rates, to control inflation and reach its objectives. The committee consists of 9 economists who meet every Thursday of every month. They have a target for CPI (Consumer Price Index) inflation, which is set by the chancellor of the exchequer of 2% ± 1%.
The committee have to consider different factors when making their decision:
o Domestic monetary developments
• Bank and building society lending figures
• High street consumer credit data
• UK share prices
• House prices
• Growth of money supply
o Exchange rate
o Demand and output figures
• Retail sales
• Consumer expenditure
• GDP figures
o Unemployment figures
So as house prices are just one factor that the economists consider when making their decisions, we can question how important it actually is. Across England, by February 2016, 64% of households own their home according to the Resolution Foundation. This has fallen to its lowest level in 30 years as the gap between earnings and property prices has increased creating a housing crisis. The proportion of people who own their own home has fallen across every part of the UK since their peak in the early 2000s. Although even though this figure has decreased, it is still over half. This means that households are very sensitive to changes in interest rates as it affects their disposable income. However, as Theresa May will announce as her second biggest housing pledge, to support people between the ages of 23 and 40 to buy their first home by helping 30 areas around the country to unlock land to build on; this will increase the sensitivity of interest rates on the housing market as more people will be affected. There are about 25 million homes in the UK, of which seven out of 10 are owner-occupied. The number of homeowners has risen by more than one million since 1997.
Although, it only affects those with tracker mortgages. Tracker mortgages are a type of variable rate mortgage which follows the base rate of interest set by the Bank of England plus a charge on top that would be pre-agreed for a set amount of time. For example, if your tracker mortgage is base rate plus 2%, and the base rate is 1%, you will pay 3%. If the base rate rises to 2%, you will pay 4%. As interest rates fall, discretionary income (income remaining after deduction of taxes) rises for those with tracker mortgages. This means those households start consuming more and as consumption is a component of aggregate demand [C + I +G + (X - M)], so aggregate demand shifts to the right.
Furthermore, as Bank of England increases interest rates, the demand for housing falls because of the decrease in the demand for mortgages. Banks’ supply of mortgage equity withdrawals begin to fall so consumers have less money so consumption decreases and aggregate demand shifts to the left. This is known as the wealth effect, which is when consumer spending is affected by a change in the value of an asset, in this case house prices.
However, we should consider whether the housing market is the most important factor that the Bank of England should consider?
With the price of houses constantly rising, consumers can find themselves facing huge deposits and mortgages that will last what seems like forever. Consumers are generally figuring out that anything less than a 10% deposit simply won’t do. George Osborne invented the Help to Buy scheme in Autumn 2013 and was described by him as a ‘landmark’ scheme that would get thousands of people on the housing ladder. Help to Buy is a government scheme which is designed to help those who are struggling to save a deposit for their first move or move up the property ladder as they have limited equity.
There were, or as of before December 31, 2016, two main elements of the Help to Buy scheme:
This part of the scheme was launched on April 1, 2013 and is available until 2020. It is open to first-time buyers and home movers; however, it is only restricted to those who are buying homes that have been newly built. If you have a 5% deposit, you can receive up to 20% government equity loan which means you will only require a 75% mortgage. A smaller mortgage means lower monthly payments which results in your home being more affordable. There are no salary cap restrictions on the scheme. The 20% equity loan is provided by the government and is interest free for 5 years. In the sixth year, you will be charged 1.75% and after that, the fee rises by inflation based on the Retail Prices Index (which is a measure of inflation measured by the ONS – the Office of National Statistics). You can pay back the equity loan when you sell your home or at the end of your mortgage period. This loan has to be paid back within 25 years or when the property is sold. If the property value has increased by the time you pay back the loan, the amount to be paid back will be proportionately higher, so the Government shares any profit.
Under the programme, borrowers were able to get a mortgage with just a 5% deposit. If those borrowers were unable to make payments, the government promised to compensate the lender.
This guarantee was available for new and old properties across the UK. However, Chancellor Philip Hammond announced the ending of the Help to Buy mortgage guarantee scheme in a letter to the governor of the Bank of England, Mark Carney, in September. He stated that the scheme was created ‘with a specific purpose’ which has ‘now been successfully achieved’.
As Mr Hammond announced the closure, the Treasury published figures revealing that more than 86,000 households had been supported by the scheme. Across all the Government’s Help to Buy schemes, a total of 185,000 were bought, 150,000 of that being first-time buyers. Although the Government says it is no longer needed as confidence has returned to the market, with more private lenders now offering similar high loan-to-value loans.
This scheme was extremely useful to first time buyers with low confidence due to the 2008 financial crisis. The Bank of England declared in September that the scheme is no longer necessary due to this. Some say that scheme only made the problem worse as it increased prices by offering cheap credit and not addressing the problem of the housing crisis. Sam Dumitriu (the head of projects at the Adam Smith Institute) said Mr Hammond made the right decision.