A year ago, the IMF had been critical of the coalition government’s overall economic strategy; this time, it declared that the UK has rebounded strongly.
However, it also struck a note of caution, highlighting some of the challenges Mr Osborne is facing in the run-up to next year’s general election.
One of the main worries, in the IMF’s view, is the UK housing market. Government figures may have shown annual price growth slowing to 8 per cent in March, from 9.2 per cent in February, but London prices were up by 17 per cent.
Transactions have risen by 30 per cent over the year, and new lending at high loan-to-value (LTV) ratios has reportedly surpassed pre-crisis levels. Introducing more stringent affordability criteria under the new Mortgage Market Review (MMR) may reduce some of the regional ‘froth’, but the worry is that a mix of strong demand, a lack of supply and expectations of further price increases could end in tears.
Traditionally, such prospects have had central banks reaching for interest-rate rises, but the IMF appears happy to endorse the Bank of England’s apparent reticence, arguing that monetary policy “should stay accommodative – for now”. Historically, however, raising interest rates does not have a major impact on house prices, so central banks have ended up increasing them to such an extent they risk triggering a recession – and such a prospect is hardly palatable.
Instead, the IMF points to macro-prudential policies as “the first line of defence against financial risks from the housing market”. Both the chancellor and the governor of the Bank of England have made similar noises, and the Bank’s Financial Policy Committee (FPC) could recommend the introduction of such policies shortly. But will they work?
The FPC has a range of options at its disposal, as the IMF acknowledges. It could recommend changes to, or even closure of, the government’s Help to Buy scheme. It could make lenders hold more capital against their mortgage loans. It could ask the Financial Conduct Authority (FCA) to place a cap on LTVs or to toughen the MMR’s affordability criteria. However, such tools may not be equally effective or effective at all in every circumstance.
The Bank for International Settlements (BIS) recently examined past experience with nine such policies in over 50 countries. It concluded only two were consistently effective: lowering the maximum share of monthly income that households are allowed to borrow, and increasing housing-related taxes, such as stamp duty. Given that tax is within Mr Osborne’s remit, not the FPC’s, and the proximity to the general election, the second option appears off limits. The fact that only one other such instrument was found to be robustly effective may well have given the IMF pause for thought. It could also explain why its strongest recommendation – the UK needs to build more houses – was not macro-prudential at all.
