The housing market is the key transmission mechanism between Bank of England interest rates and the wider economy. When the UK economy is weak, UK interest rates are cut in order to reduce the cost of borrowing. Cheap borrowing costs encourage consumers to spend more, and the biggest beneficiary is the housing market. A strong housing market generates a wealth effect, resulting in strong economic growth. Eddie George was recently accused by the press of deliberately fuelling the consumer boom, but this is precisely how the Bank of England uses monetary policy to manage the economy through the economic cycle.
When the housing market (and hence the economy) is growing fast, rates are hiked. In the late 1980s the Bank of England was a little too aggressive -it doubled interest rates from 7.5% in 1988 to 15% in 1989 in an effort to slow the housing market and subdue inflation, but the result was recession and a housing market crash.
The economy today is in a much better shape than in 1989, but the issues facing it are similar. The Bank of England has kept interest rates too low for too long, as shown by a UK housing market that’s growing by around 10%per annum. Inflation is pushing the 3% upper limit, and the Bank of England has no choice but to hike rates in order to put the brakes on the housing market and dampen economic growth. It may even have to risk recession to do this.