London gives BoE an emerging economy problem

April 23, 2014

By Ian Campbell

The author is a Reuters Breakingviews columnist. The opinions expressed are his own.

The UK has a popularity problem which the Bank of England cannot solve. Foreigners have an unhealthily strong desire for London property. Before the financial crisis, many emerging markets tried, and basically failed, to deal with a similar excess of attention.

The central bank’s Monetary Policy Committee is not focusing on the issue, to judge from the latest minutes, published on Wednesday. That’s a shame, since the capital flows and regional distortion risk undermining the whole nation’s economy.

London is in a housing bubble. Property prices are up 18 percent in a year, and are 19 percent over their 2007 peak, according to Nationwide Building Society. The average in the capital is now twice as high as in the rest of the country, above the previous 80 percent peak premium. Non-London housing markets are mostly recovering, but the average price is still below the previous peak, much like British GDP. The economy’s thaw is still slow.

Much of the money used to bid up London’s market is foreign. The funds flowing into property and other UK assets are so abundant that a huge current account deficit, well over 5 percent of GDP in the second half of last year, was not enough to weaken the pound. On the contrary, the currency is rising, crimping UK competitiveness and its sustainable growth.

Before the global bubble burst, central bankers from Brazil to Turkey tried to discourage foreigners from bidding up their currencies. But nothing – rate cuts or rate increases, strong words and taxes on capital flows – really worked.

The BoE faces a similar shortage of effective tools. Capital controls are still out of the question and restrictions on lending are likely to be ineffective when so many of the foreign buyers are paying entirely in cash. An interest rate rise is less likely to burst the London bubble than to depress the rest of the economy – and could drive sterling still higher.

A burst bubble too has risks. It can bring sudden currency weakness, an inflation spike, and a need for higher interest rates – the last things needed in the still slow recovering UK.

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