Bank says house market heading for meltdown

Stark warning over interest rates

The housing market could be heading for collapse, the Bank of England said yesterday, warning that the current surge in property prices was "unsustainable".

David Clementi, the Bank's deputy governor responsible for financial stability, warned interest rates would have to rise if the consumer boom did not fade of its own accord. "I think it is appropriate that homebuyers and lenders exercise a degree of caution," he told the Commons Treasury Select Committee. "It bears repeating: the level of house price inflation is unsustainable and the longer it goes on the sharper is likely to be the adjustment."

The comments mark a significant shift from the view expressed by Mr Clementi as recently as April, when he said evidence of a house price bubble was "not conclusive" and the buoyant housing market did not raise "undue concerns".

House prices have continued to soar since then. Figures from Halifax earlier this month showed prices jumped by 4.2 per cent in May alone, taking annual growth to 18.5 per cent, with Britain's biggest mortgage lender saying rises were fuelled by low interest rates, low unemployment and a lack of quality properties coming onto the market.

Sir Edward George, the Governor of the Bank of England, said the Monetary Policy Committee would have to act if it felt the boom was going to push the underlying rate of inflation beyond its target level of 2.5 per cent. He pointed out that this was the MPC's specific brief and that it was "not in the business of controlling the housing market".

He said: "We do not believe the current rate of house price inflation is sustainable, but it is a factor driving consumer spending. If we found it [consumer spending] was not moderating, we would have no option. We would have to tighten policy to bring that moderation about."

However he said a crash was unlikely: "We are not expecting boom-bust in the housing market that would cause us to undershoot the inflation target substantially."

Even so Mervyn King, the Bank's other deputy governor, said the rate of consumer spending needed to halve over the coming years. He added that he expected a significant difference between first and second-quarter gross domestic product growth. There was surprise last month when the Office for National Statistics revised its estimate of GDP growth for the January to March period down to zero, suggesting a two-speed economy in which output is stagnant but consumer spending rampant.

Economists said the comments increased the chances of the MPC increasing rates from their current level of 4 per cent at its next meeting, in early July.

Tempers became frayed later in the meeting when Liberal Democrat MP David Laws clashed with Mr King, who is strongly tipped to succeed Sir Edward when he retires next year.

Mr Laws pressed Mr King on whether he had moderated his hawkish view on inflation in order to increase his chances of landing the top job. A clearly angered Mr King responded: "The cynicism of politicians is not something you should necessarily visit on everyone else. I give you a total assurance and I look forward one day to an apology in return."

Sir Edward intervened, saying Mr Laws' comment was "an extraordinarily cheap remark" that had gone "beyond a joke".

The FTSE 100 fell 79.8 points to 4771.9, though the dip was attributed largely to weaker than expected US retail sales figures.