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Will Mervyn King have to explain why inflation has undershot the MPC&#39s target?

The cebr says that the release of the figures from HBOS implying that UK house prices rose by 5% in October (which the Monetary Policy Committee had at the time of their interest rate decision) helps explain why the MPC didn&#39t cut rates in November.

Cebr data (and that from the Land Registry) suggests that the HBOS data is exaggerating the increase in house prices, though the cebr has always made clear that it expected that housing affordability at low interest rates would mean, when combined with lack of supply and rising household numbers, that house prices would rise faster than average earnings for some time.

Its Housing Futures 2012 report, released last April predicted, that the average house would cost over £300,000 by 2020 and the latest data shows prices moving in that direction.

Cebr chief executive Douglas McWilliams says: “The Monetary Policy Committee is caught in a bind. On the one hand it is well aware that if it cuts interest rates it risks pouring petrol on the flames of house price inflation. As we pointed out last week, rising house prices have boosted consumers spending this year by allowing consumers to increase their mortgages to withdraw equity. We estimate that this will have financed 5.9% of consumer spending this year, up from 3.8% in 2001.

“There is some evidence that consumer spending is becoming less tightly connected with house prices in the UK but the gearing has certainly not yet fallen to zero. Potentially this is good news for retailers in the run up to Christmas, particularly as they appear to have been cautious in their purchasing. Watch out for stocks of favourite items to run out in the pre-Christmas shopping rush and for retailers to post rather better profit margins than hitherto (also for the January sales to have much lessdiscounting than usual).

“But, although there are some upward influences on retail price inflation – seasonal food crops affected by bad weather, rising consumer taxes in the Budget, the possibility of an oil price spike if Iraq is invaded and the likely lack of discounts in the January sales – the underlying trends for prices show little evidence of pricing power by UK companies.

“We expect that consumer spending will weaken in 2003. If UK interest rates stay at 4% (well above those likely to apply in other countries like the US, Japan and the eurozone by then) sterling could more than recover its losses of the past year. Our base line forecast in September was that even with a weaker pound the rate of inflation would fall to the 1.5-1.8% range in mid-2003. If UK interest rates are not reduced, the chances are that next year the rate of inflation will fall outside the MPC&#39s target range.

“At this point, the relevant legislation says that the Governor of the Ban (which might by then be Sir Edward George&#39s successor) will have to write a letter to the Chancellor explaining why the MPC had let inflation undershoot. It would be poetic justice if the task of doing this fell to the current Deputy Governor, Mervyn King, who has consistently been the most hawkish of MPC members.”


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