Personal Finance: Banking on the home instinct

Booming house price in parts of Britain have triggered a mortgage rate hike signalling the end of a virtuous circle of falling home-loan bills and rising property values.

Homebuyers face higher repayments from October after the Bank of England's surprise decision to lift interest rates by 0.25 per cent, even though inflation generally is running at very modest levels. The question is how much higher must rates rise to bring the housing market to heel?

Experts are divided over whether this first warning shot across the bow of the property market will puncture ballooning prices. What it does signal, however, is that, for the first time since the late 1980s, the Bank of England is keeping house price inflation under close scrutiny.

The Halifax moved first to rachet up the cost of borrowing, but not by the full 0.25 per cent. By opting for a 0.14 per cent increase, the Halifax has added just pounds 5.04 to the monthly bills of 60,000 borrowers. A larger pounds 100,000 loan will cost pounds 8.64 more.

The general view is that this whimper is not going to send the market crashing with a bang. One City housing market analyst argued: "This will do nothing to alter the fact that four or five people are chasing every house in some areas. We have a supply and demand problem.

"Mortgages remain very cheap by historical levels, and interest rates would need to rise significantly for that to alter. There is a great deal of pent-up demand with first-time buyers now ready to enter the market, and families looking to move up.

"The simple fact is not enough people are selling, and that is keeping transactions subdued. It would take a recession, or interest rates of 15 per cent, to stop the market in its tracks."

But a recession or significantly higher interest rates is the last thing on the Bank of England's agenda. While homeowners may well shake off this small increase in costs, businesses may not find the burden so easy to shoulder.

However balancing the needs of the wider economy while curtailing the excesses of house price inflation could prove problematic over coming months. Once on his feet, the property market is a piper who dances to a tune all of his own.

Much higher loan rates are not only unnecessary, given that overall inflation is well below the Government's target of 2.5 per cent, but would wreak untold damage on the wider economy, and most likely trigger a recession.

Yet the dangers of a soaraway housing market cannot be ignored. Huge surges in the South-East and other regional capitals cannot be dismissed as local events. The bank hopes that, by taking precipitate action, it may avoid even higher rates. And that plan may succeed if this initial hike acts as a psychological deterrent, as the Bank is obviously hoping, and some lenders believe will be the case.

A Nationwide spokesman said: "The significance of this increase is that it is the first upward move for some time. People are going to think, hey, is this the beginning of a cycle or rising rates and just how much further will they go? That should make them more cautious when they put in offers, which should help to dampen price rises."

The good news is that, even if this marks the beginning of the next upward swing, most within the mortgage industry believe rates will not rise far. For example, the Abbey National's chief economist, Barry Naisbitt, believes that, as mortgage rates peaked around 8.5 per cent in the last cycle, they will do so even lower this time round.

That may be a touch too optimistic, given the much greater overheating evident in the property market and the army of opinion against small rises having any impact on house prices. Direct Line Financial Services managing director Stephen Geraghty also points out that in many ways base rate rises are an irrelevance to the way modern deals are designed. He said: "Our mortgage rate depends on what we are paying our savers and what is happening on the wholesale money markets. Rates rose there some time ago and are not showing signs of leaping further at the moment. There is no inextricable link between base rates and mortgage rates as the traditional lenders seem to claim, which means there will be some very competitive deals around for some time."

The Woolwich too, which has its heartland in the booming South-East, sees no prospect of this latest rise choking off either demand or prices. The Bank of England must be crossing its fingers it is guessing its primary market wrong.