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House price inflation to slow in 2007

The rate of house price increases is likely to slow in the coming year as the recent base rate rises gradually have an effect on borrowers’ finances, says Ray Boulger, senior technical manager at John Charcol

The two increases in the base rate last year reflect the Bank of England’s concern over inflation. Comments from BoE governor Mervyn King certainly indicate that the Monetary Policy Committee is uncomfortable with the level of house price inflation.

These rate rises have not yet produced a slowdown in the rate of increase in house prices for two reasons. First, it is too soon for most indices to reflect the impact of the November increase. Second, at this time of year the seasonally adjusted monthly figures reported by HBOS and Nationwide – and hence the ones focussed on by the media – seriously distort the real figures which show about 1% lower growth over the past three months than headline rates.

At least Nationwide publishes the real figure each month as well as the seasonally adjusted figure, but HBOS only publishes the real figure quarterly.

Economists’ forecasts about where the base rate will end 2007 range from 4% to 6%. But more importantly – because it reflects where people are prepared to bet real money – the interest rate futures market is discounting another 0.25% rise in the base rate in the first half of 2007 and partially discounting another 0.25%, with the expectation the rate will stay at 5.25% or 5.5% until the end of the year.

A move to either 4% or 6% in the space of only 12 months would have a significant impact on the housing market but unless we experience a major economic shock it is hard to see the justification for such a large move.

In a speech at the end of November BoE deputy governor Rachel Lomax highlighted the risks to the economy of raising interest rates too far, encouraging the view that the base rate is at or close to its peak for this cycle. This suggests the MPC is keen to see the impact of the two recent base rate rises before seriously considering another increase.

The two recent rate rises for borrowers, the large increases in energy bills for all consumers last year and the cumulative effect of chancellor Gordon Brown’s various tax increases over the years indicate a slightly softer economy later in 2007, even without another rate rise. This might allow for a small fall in the base rate to end the year at 4.75%, even though in the meantime it may increase to 5.25%.

So what will be the impact for borrowers? According to Council of Mortgage Lenders figures, about two-thirds of all new mortgage borrowers in 2006 chose fixed rates. But over half of all mortgages are on variable rates and most borrowers who bought fixes took out rates that were only fixed for two years. Therefore interest rate rises will affect many borrowers instantly, and even more within just two years.

On a typical new repayment mortgage of £110,000 the combined increased cost of the two recent rises is about £400 per year and the 25% of borrowers with interest-only mortgages will pay an extra £550 per year.

I expect the rate of house price increases to slow in 2007 as the recent interest rate rises gradually bite, resulting in an increase in house price inflation of around 4.5%, albeit with significant regional variations.


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