Is housing close to the edge?

Will interest rates go up, down or stay the same this week?

Most economists think that the rate setters at the Bank of England will stay their hand after last month's quarter-point hike. Of the 32 economists polled by news wire Thomson Financial last week, only three forecast a rate rise this week.

So does that mean rates have peaked?

Not so fast. Most economists think that interest rates will go up at least once over the summer. Some think that they could hit 6 per cent by the end of the year. This view was reinforced by the minutes of last month's meeting of the Monetary Policy Committee (MPC). They showed that some of the committee members who voted for a quarter- point rise had actually considered a half-point hike. This would have been the first time interest rates had moved by more than a quarter point since the Bank's independence in 1997.

So why are interest rates on their way up?

The job of the MPC is to keep the consumer price index (CPI), its chosen measure of inflation, at 2 per cent.

If inflation deviates by more than 1 per cent from the target, the Bank's Governor, Mervyn King, has to write a letter to the Chancellor explaining why. He did this for the first time in March when inflation hit 3.1 per cent.

This rise explains why rates are going up. According to the Organisation for Economic Cooperation and Development (OECD), Britain has the worst inflation problem in Western Europe. The CPI fell last month to 2.8 per cent but this still puts it way above the target of 2 per cent. The MPC has repeatedly warned that there is a greater risk of inflation rising than receding, especially as food and energy prices are increasing. Shops are also raising prices quickly and shoppers show little sign of easing spending.

What about house prices?

There are signs that the most recent spurt in house prices, which began 18 months ago, is coming to an end - outside London at least. Last week, the Bank reported that mortgage approvals fell for the third month in a row in April to the lowest level for a year - signalling that homebuyers' appetite for taking on more debt is waning.

But it is important to remember that the MPC's job is to keep inflation - as measured by the CPI, which excludes mortgage payments - as near to the 2 per cent target as possible.

The MPC did not try to prevent the house price boom by lifting rates higher, so hard-pressed homeowners should not expect the committee to ease rates if house prices fall.

So will there be a crash in house prices?

This is something that many well-paid and clever pundits have been predicting - in vain - for years. The housing market has seen three main growth periods since the boom began in 1999. The first lasted until 2001. Then, in the wake of the terrorist attacks of 11 September and the stock market crash, interest rates were cut, which ended up stimulating a second phase of double-digit price rises. House prices paused for breath in mid-2004, and at the time Mr King warned that the risk of a housing crash was increasing, saying prices were "well above what most people would regard as sustainable in the longer term". In the following months, the talk among estate agents and the media was whether the Bank could avoid a "hard landing" for the housing market where prices fell significantly.

These fears were misplaced. Following an 18-month pause in price rises, the market started gathering steam again at the end of 2005, particularly in London and the South-east.

The big difference between now and the last pause in price increases is that interest rates are now 5.5 per cent compared to 4.5 per cent in August 2004. And, as we have already explained, the cost of borrowing is set to go even higher.

If rates go above 6 per cent, many homeowners will have difficulty paying their mortgages and the market could be flooded with forced sellers. Some pundits are predicting that rates could go as high as 7 per cent in the current cycle, which would really send us into nosebleed territory.

Is it the end of the buy-to-let boom?

This is probably the most vulnerable part of the housing market. Even if the rest of the sector copes with further, limited rate increases, the UK's love affair with buy-to-let could finally be coming to an end.

The rental income of many investment properties does not cover the mortgage, but landlords have been happy to make up the shortfall as long as rising property prices will net them a profit when they sell. But once prices start to falter, buy-to-let will become a lot less attractive.

Further browsing Read pundits' views on www.houseprice- crash.co.uk

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