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Thursday, 6 February, 2003, 15:39 GMT
Rate cut 'to inflate house price bubble'
For Sale signs
Price rises are expected to slow later this year
The dramatic cut in interest rates announced by the Bank of England could have a damaging long-term effect on the housing market, according to an economic consultancy.

The move by the Bank of England is meant to bolster a weakening economy, but the housing market remains strong - growing at 25% a year according to the latest Halifax Bank survey.

We are more worried not less by this rate cut. It means that house prices are likely to go beyond current historically high levels and they are overvalued as it is.

Jonathan Loynes Capital Economics

Capital Economics, which last December predicted that house prices could fall by up to 30% over the next few years, has told BBC News Online that the rate cut could make matters worse rather than better.

Savers are also in the firing line as the Bank of England rate could spell lower returns on their investment.

Short term boom

The Bank of England decision to cut rates from 4% to 3.75% took borrowing costs to their lowest level since 1955.

Following hard on the heels of the cut, Virgin One immediately slashed rates for borrowers by 0.25%.

If more lenders follow suit, homeowners would see the monthly repayment on a 60,000 loan fall from 377.46 to 368.45.

Nationally we are seeing modest price rises, the UK economy is not diving into recession... if that stays the case then we are unlikely to see a large price correction

Milan Khatri

But Jonathan Loynes, chief economist at Capital Economics, told BBC News Online that what may seem like good news for homeowners in the short term may prove damaging over a longer span of time.

"We are more worried not less by this rate cut. It means that house prices are likely to go beyond current historically high levels and they are overvalued as it is.

As a result, when the correction comes, it will be sharper and will impact more people than it would have if this rate cut had not taken place."

No crash ahead

However, Milan Khatri economist at the Royal Institution of Chartered Surveyors (RICS) said that the Bank of England cut was: "an appropriate response to tentative signs of a cooling in consumer confidence and spending."

Mr Khatri added that the cut would not prevent a slowdown in house price growth during 2003 as fears over war in Iraq and a weakening economy are weighing down on homeowners

But crucially Mr Khatri maintains a slowdown does not spell a crash.

"Nationally we are seeing modest price rises, the UK economy is not diving into recession if that stays the case then we are unlikely to see a large price correction."

Savers feel pain

Savers are likely to feel the pinch as a result of the rate cut.

As a rule of thumb, when the Bank of England cuts rates banks and building societies find it harder to maintain rates paid to savers.

The average High Street instant access savings account is already paying less than 1% to savers, according to financial research company Moneyfacts.

The Bank of England move is likely to deteriorate returns further.


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