My home is my bond

UK houses look expensive, like German bonds

Houses and the UK economy are still locked in their habitual unhealthy embrace. The economy is recovering and so, too, are house prices. The Halifax index shows the average price in May was 3.7 per cent higher than a year earlier. But house prices begin this recovery unaffordably high, propped by ultra-loose money - just like UK and German government bonds. What happens when monetary policy returns to normal?

The problem is the price level from which this recovery begins. Houses normally become affordable during big economic downturns. They haven't this time, by the conventional measure. In the first quarter of 2013 the average UK house price was 4.5 times average earnings, above the average ratio of 4.1 since 1983, and far above the 3.1 of the mid-1990s after the big housing bubble of the 1980s burst.

The resilience of house prices reflects inadequate supply and monetary policy excesses. The Halifax reports that while house prices are well above average, mortgage payments are well below: 27.8 per cent of earnings in the first quarter, compared to the 36.2 per cent average and not far above the all-time low of 23.6 per cent.

That's what comes of a Bank of England base rate of 0.5 per cent and the injection of £375 billion of cash into the financial system from quantitative easing. If that's not enough, the authorities want even cheaper mortgages. The Bank of England has a Funding for Lending scheme and the government a particularly ill-advised Help to Buy plan, which tops up borrowers' deposits.

But UK interest rates won't stay at 0.5 per cent forever. Mortgage rates could rise substantially when growth and inflation go higher, as they may do by 2015. This could mean the recovery in the housing market reverses, hurting borrowers, lenders, the economy and the government.

There is no easy solution. Homes are a financial asset and all asset prices are out-of-kilter. Building more houses, reducing their scarcity and cheapening their real cost would be wise. But even that would add to the risks for those who buy overpriced houses in the next price upswing.