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