To what extent does the Housing Market Effect Interest Rates?

Recently the governor of the Bank of England admitted UK monetary policy may have been responsible for encouraging a consumer credit boom and also boom in house prices.

With many commentators arguing house prices are overvalued (House prices set to fall) a good question to ask is why didn't the government and MPC do more to reduce the housing boom? e.g. they could have increased interest rates earlier to prevent house prices rising too much.

In short the answer is that interest rates are used to meet the governments inflation target. The housing market is not a direct objective of monetary policy.

The other reason is that the underlying reason for the rapid increase in house prices is the fundamental shortage of supply. Because demand is fundamentally greater than supply using interest rates to reduce house prices doesn't tackle the fundamental problem in the housing market.

To be fair to have prevented rapid house price inflation interest rates may have needed to be quite a bit higher, this could easily have contributed towards a downturn in the economy.

For more details See: Effect of Housing Market on Interest Rates

• UK Housing Market

Stock Markets Lose Apetitie for Risk

This has been one of the worst weeks for the Dow Jones for 4 years - the stock market fell 4.2% this week. In particular brokers are becoming more wary of buying risky assets.. In part this stems from worries over the US housing market's sub prime market. This is basically lending mortgages to people with bad credit histories. These kinds of loans are more risky, but in the past house prices rose rapidly in the US. Now that house prices in the US are falling, there are increasing concerns that this kind of mortgage lending is too risky. Therefore the risk premium of insuring such mortgages has increased significantly.

Some brokers fear the worst for the stock markets is over. But the big question is whether falling house prices could tip the US economy into recession.

Effects of a falling stock market on US economy