The great exploding housing bubble

As we inflate another house-price bubble, which is bound to burst eventually, the Bank of England has taken its eye firmly off the ball.

Mark Carney, the Bank’s new governor, has said interest rates won’t go up until unemployment falls to seven per cent – unless the outlook for inflation is that it will be above 2.5 per cent in 18 months’ time.

This is a cop-out because the Bank’s “fan chart” for future inflation will cover every eventuality from 0.1 per cent to 10 per cent.

More worrying, though, is that the Bank’s target of two per cent is based on the Consumer Prices Index, a measurement of inflation which completely ignores house prices.

In an economy so dependent on home-ownership, house price inflation is very significant.

Not only does it tell us how fast house prices are rising, it is used to measure the country’s GDP and, therefore, it has a significant impact on consumer confidence.

The faster house prices rise, the more liberal people are with their money, the more they are likely to borrow and the quicker the economy grows.

This is, in many respects, all to the good. But – and it is a massive but – because the Bank doesn’t take any of this into account when setting interest rates because none of it affects CPI, the end result is that its policy ignores the elephant in the room.

If house price inflation were included in the calculation of general inflation, it is highly likely interest rates would have been higher in the mid-2000s. That would have slowed the housing market, led banks to lend less and would not have encouraged people to borrow more than they could afford, thus reducing the house-price spiral which ended up strangling the life out of the entire economy.

I am told there is no such thing as an inflation measure which includes house prices. This is because inflation measurements are based on an international standard.

But in this country the economy is much more heavily dependent on a buoyant private housing market than it is in many other European nations, where the renting your home is more prevalent.

The other reason we don’t include house prices is because statisticians regard houses as capital investments not day-to-day spending. That’s a fair point but it fails to take into account the impact – psychological as well as economic – of house-price inflation.

Mr Carney is already guilty of abandoning the remit of the monetary policy committee and prioritising unemployment – not part of his remit – above inflation.

That’s bad enough. It is made worse because, as long as the Bank fails to account for rising house prices, the inflation statistics it uses are meaningless. They have only have a passing resemblance to the real economy.

The credit crunch and the worst recession in living memory were caused by rampant house-price inflation which was allowed to go unchecked by the Bank because it was aiming at the wrong target. It seems nobody has learned from this terrible mistake.