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Mark Chilton on mortgages

Recent events have seen a sea-change in the political and economic environment, both of which have a bearing on the mortgage industry. I am talking about the decision to shift interest rates again by 0.25 per cent within one month and the overall political uncertainty caused by the Local and European elections.

Sustained house price inflation has led to the growth and continued strength of consumer spending. For the average person, the value of house price inflation in the UK today, is like receiving a 60 per cent bonus every year on their income. Is it no wonder we seeing more equity release and more fuelling of consumer spending in this environment? So the bank will continue to focus on house price inflation as a primary driver of their interest rate policy. Sadly, it has have failed to recognise the more complex dynamics that interest rates have in the housing market today. We are still operating at fundamentally low interest rates. Housing is simply, with the exception of the first-time buyers, too affordable for all those who are already on the housing scale.

If the bank wants to control house price inflation, it has to address emotion and deliver a shock to the system. Two 0.25 per cent rises within a month goes some way to achieving this but it would have been far better served by pushing through two 0.5 per cent rises over the past year rather than the incremental approach, which has not been seen to be working.

The impact of interest rates on house price inflation is far more complex than might at first be seen. With a generic move to fixed-rate mortgages, great swathes of the population are not affected by short-term moves in interest rates. As swap rate moves up, fixed rates get more expensive but people are buying these with the optimistic outlook that in two years, when the majority end, the interest rate environment is likely to be more benign. Second, even for those on variable rates and their derivatives, the impact of a 0.25 per cent rise does not get through to the borrower&#39s purse for at least three months. Finally, we still have any number of borrowers on annually adjustable rates.

If we continue with the incremental strategy, we are likely to see rates reach higher levels than are necessary, with potentially worse long-term impact on the housing market and the economy. Sustaining the incremental approach could lead not to a total collapse in house prices, but the stagnation that is feared by many.

But there is good news in the political outlook. The elections must surely have delivered a hammer blow message to Tony Blair that to be re-elected he must focus on protecting the interests of middle England.

I am readjusting my outlook for this year, based on the events of the last few days. I think it is likely that we are going to see another two 0.25 per cent rise in base rate, which, although unnoticed by the mainstream press, will continue to see lenders retaining their full margin.

As to house price inflation, I am increasingly of the view that although the balance of this year will see inflation sustained at 10 per cent, 2005 and probably the next three years thereafter will remain relatively stagnant, with house price inflation operating at sub-RPI levels.

Mark Chilton is chief executive of Purely Financial Group

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