Assetz® News - Liberal Democrats in new interest rate plan

Liberal Democrats in new interest rate plan

18th September 2008 |

In a week when the headlines have been dominated by Lehman Brothers, AIG, the HBOS takeover by Lloyds TSB and the general mayhem on the stock markets, the start of the party conference season in Britain has been somewhat overshadowed.

The absence of Liberal Democrat leader Nick Clegg from the front pages after his keynote speech to delegates in Bournemouth yesterday may disappoint supporters, but nonetheless, there was some substance in the speech that may have implications for the future of how interest rates - and therefore mortgage costs - are set.

Listing some policy pledges to create "future economic stability", Mr Clegg said this would include "interest rates that take house price changes into account". While not specifying further how he might do this, there is one obvious way in which this might take place - that of changing the emphasis of the monetary policy committee's (MPC's) remit from targeting a particular consumer prices index (CPI) level (two per cent under current Treasury rules) to aiming at a particular retail prices index (RPI) figure.

The difference between the two is the inclusion of house prices in the RPI figures. The significance of such a move may have been borne out this week, during which the Office for National Statistics (ONS) produced its inflation figures for August and the MPC minutes for the September meeting were also published. The latter showed little movement towards any rate cut. The one perennial supporter of such a move, David Blanchflower, voted for a 0.5 per cent cut instead of his normal advocacy of 0.25 per cent and Tim Besley voted to hold the rate rather than supporting a 0.25 per cent rise as he did in July and August. But the other seven stuck fast to their support for the status quo.

A good reason for this may be that CPI has carried on rising, as ONS figures revealed this week, up from 4.4 per cent to 4.7 per cent in August. In the second letter he was obliged to write to the chancellor about why CPI is above three per cent, the Bank's governor Mervyn King said a period of low growth in the economy may be necessary to bring CPI down. If this translates into a continued persistence of higher rates, this may delay the housing market recovery.

Under a plan to target the RPI rate, however, matters may be very different. The RPI figure for August dropped from five per cent to 4.8 per cent as further housing price drops fed through. Faced with a falling inflation rate, the MPC could act very differently, particularly if this was stipulated in their remit. The contrast between the two inflation trends may give a clear indication of how the proposal by Mr Clegg could represent a major shift in monetary policy.

Such a policy is unlikely to be introduced by a Liberal Democrat government, given that neither they nor any of their Liberal predecessors have run the government or even the official opposition since the early 1920s. But the issue could well be pressed were the next election to produce a hung parliament and leave Mr Clegg holding the balance of power. In the meantime, as the residential property market remains subdued, those investing in rental property could go on having the best time of it in the near future.