Although there are few credit-led bubble signs, the UK has received a risky mortgages warning from the International Monetary Fund (IMF) in its “United Kingdom — 2014 Article IV Consultation Concluding Statement of the Mission,” which contained twenty-three comments and recommendations.
House price inflation is becoming more widespread and is particularly marked in London, the IMF wrote. It warned that the steady rise in the size of new mortgages in relation to borrower incomes indicates that households are becoming progressively more vulnerable to sudden changes in income or interest rates.
Help to Buy (HtB), a government backed scheme that aims to help first time buyers purchase their homes, is enabling creditworthy lower-income individuals and families buy their homes, especially in the Southeast and London, says the IMF. The scheme has also helped unlock mortgage credit for lower-income households from other sources.
It added that the UK needs to build more houses, something Mark Carney, the Governor of the Bank of England commented last month.
Healthy growth, subdued exports
The UK economy has recovered strongly and GDP (gross domestic product) growth is now more balanced. Since the second half of last year growth has picked up, and leading indicators point to an economy that is gathering steam.
Initially, GDP growth was led by household expenditures, but is now also being driven by a healthy increase in business investment. However, “exports remain subdued,” the IMF pointed out.
According to the Office for National Statistics, the UK’s trade deficit in goods and services increased in April to £2.5 billion compared to £1.1 billion in March.
Low Inflation and good macroeconomic performance
Inflation has fallen steeply. In spite of disappointing productivity growth and the recent increase in demand, inflation has fallen to well within the Bank of England’s target of 2%.
Inflation has come down because of lower import prices, moderate wage increases, the diminishing impact of administered price increases, and weaker margins.
The IMF believes the UK’s healthy macroeconomic performance will persist, with strong GDP growth forecast for 2014, “before gradually returning to trend rates, driven by further rebalancing toward business investment and a gradual recovery in productivity. Inflation is expected to revert to target.”
Two risks: low productivity gains & the external environment
For sustained economic growth productivity needs to improve. Productivity growth is well below historic norms.
For investment and output to increase over the long-term, productivity growth needs to pick up. Productivity is currently “flat”, says the IMF. If this does not improve GDP growth will eventually halt.
There are several potential risks in the external environment. The Federal Reserve’s tapering of its stimulus program could trigger disruptions to the world economy, emerging markets and the Eurozone are vulnerable to financial shocks, the Ukraine-Russia crisis and other geopolitical tensions could affect trade and investment.
Although the UK is not directly exposed to these risks through financial channels and trade, the IMF writes “The realization of any, in concert with a repricing of risk from the current unusually low levels, could depress asset prices and damage confidence.”
Monetary policy
For the time being, the IMF believes monetary policy should remain accommodative. With excess supply, inflation well within the central bank’s target, and contained cost pressure, the UK’s monetary policy should not change.
If costs rise more rapidly than productivity growth and slack is absorbed, policy may have to be tightened.
Interest rates should rise before the selling off of assets when it is time to normalize monetary conditions, the IMF emphasized. “Should changing conditions require reversing the normalization, decreasing the policy rate would likely be less disruptive than repurchasing gilts.”