Creating an Artificial Demand is Playing with Fire

Nick Moules asks whether the Funding for Lending Scheme is a foundation for growth or the country backing a market it can’t possibly keep up with.

There is a tendency for the good times to be referred to as “normal” by business journalists – consumer spending habits in the years preceding the credit crunch were unprecedented, yet are regarded as a realistic benchmark to return to (“getting back to normal”). Society appears incapable of accepting a boom for what it is, rather we’re in a plateau, but returning to the boom level would be normal – as everything must inherently keep rising…

The latest research published by Ernst & Young in its Item Club suggests consumer spending growth will rise by 1.2% this year, growing again next year to 1.9%. By 2015 it will be back to 2.2% – the level it was at before the crisis.

All the rhetoric points towards consumer spending being the ultimate aim of the UK’s economy.

The reality is that even if consumer spending were to return to levels seen up to 2007, underlying conditions in the UK are a long way from where they were when that sort of spending existed. Shouldn’t it be about consumer spending as a result of a thriving economy?

How will this increase in spending be financed? Is it through a thriving economy with huge demand at home and abroad, rising wages or a cut in the cost of living?

Probably not.

It could come from credit cards as the population tires of paying down debts and cutting costs. It might come from extra cash released as homeowners remortgage to take advantage of some of the lowest rates on record.

There are signs of the UK housing market beginning to find momentum again, fuelled by the cheap credit injected by the Funding for Lending scheme.

With some lenders offering 10-year fixes at less than 4% you would have to presume there is some carefully-worded small print in there to protect the bank and its stakeholders against dramatically rising interest rates.

It’s perfectly conceivable that the base rate could by over 10% (some would refer to this as “normal” by referencing the long-term trends in the base rate) by the time this deal matures. That could cause a serious headache for lenders if that proves to be the case.

There has been much criticism of the Funding for Lending Scheme, with many seeing it as a toxic step for the Government to take. It is acquiring a stake in a market that has historically risen, but arguably at too fast a rate in the last decade. Even the last couple of years have comfortably exceeded the long-term trend for house price growth, so it will need to slow down to get in line with flat wages, rising living costs and a turgid economy, rather than accelerate.

If the Funding for Lending Scheme stops, you could see negative equity quickly creep in again. In the first place prices inevitably rise, those who can access the funds buy, but then if there’s no-one coming in at the bottom when the money dries up, as a recent buyer, you’re left with a property you can’t sell. While those who want to get into the market have to find 10% of a price much higher now than it was a year ago to get a deposit together.

If the Government takes the view that the UK economy is ultimately reliant on a buoyant housing market, then you can see why the scheme exists.

Undoubtedly, building jobs will be created and everyone involved in the process of buying and selling a house will see business increase. It is also based on the principle of supply push, only it would probably be healthier if people were making purchasing decisions (and financing those purchases) without artificial support, or demand pull. It would suggest affordability is real and prices truly reflective of the market’s ability to meet them.

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