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?