Housing Market: 14.8 Housing Market and the Euro

In June 2003, the Chancellor announced to the House of Commons the results of the Treasury’s latest assessment of the Five Tests related to the UK’s membership of the single currency.

The special study on ‘Housing, Consumption and EMU’ (one of the 18 individual reports) concluded that:

‘Differences in housing and mortgage markets between the UK and euro area countries suggest the potential for greater sensitivity of household spending to interest rates in the UK.’ (p 85)

This conclusion was based on a number of key differences between the UK and euroland housing markets.

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Differences between the UK and euroland housing markets

These are the key differences between the UK and euroland housing markets:

  • real house price growth has been stronger in the UK than in the larger euro countries and the low response of housing supply in the UK appears to be an important reason for this;
  • high levels of mortgage debt in the UK, combined with the dominance of variable rate mortgages, implies that the sensitivity of household interest payments to changes in interest rates is higher in the UK than in the euro area countries;
  • the UK owner occupation rate is well above the levels in the larger eurozone countries;
  • the competitive, liberalised mortgage market in the UK makes it easier for households to access their housing wealth (i.e. equity withdrawal); and
  • there is little evidence of convergence of housing and mortgage markets within the eurozone following the launch of the euro.

Joining single currency would increase risk of instability

If control of monetary policy in the UK passed from the Bank of England to the European Central Bank, therefore, it would increase the risk of instability in the UK.

This is because, given the level of debt and the larger share of variable rate mortgages here compared with the eurozone, any given interest rate change would have a disproportionately greater impact on the UK, and the housing market would be the transmission mechanism.

This was also the case when the Tests were first assessed in 1997. Now, however, given the boom in house prices and the higher levels of borrowing that have occurred since then, the divergence has widened and the UK’s vulnerability in this area has increased, particularly as eurozone interest rates have been higher than the Bank Rate in the UK in 2009.