There are few things quite as dull as a monetary policy report. For many people, the term ‘monetary policy’ is enough to immediately lose their attention. It is understandable, monetary policy relies on economic theories, the reports often use financial jargon to refer to complex tools and changes are often measured in basis points (one-hundredth of a percent). It is not exactly the kind of material that would get someone out of their seat. However, this can be problematic as monetary policy is integral to property investment. In fact, it is integral to property ownership in general.
The positive news is that Landlord Vision is here to explain why monetary policy is important and to keep you up to date with what you need to know.
What is Monetary Policy?
Monetary policy is one of the key economic levers available to central banks. It is used to control both the supply of money in an economy and the cost to borrow money. In the UK, the Bank of England (BoE) uses monetary policy to control inflation, with a target of keeping annual inflation at 2%. To do this, the BoE has two main tools:
- The Bank Rate
- Quantitative Easing (QE)
The Bank Rate (commonly referred to as the ‘base rate’ or ‘Bank of England interest rate’) is the rate at which the BoE lends money to commercial banks. This directly impacts the rate at which commercial banks lend to their customers. The higher the bank rate, the more expensive it is for property investors to borrow money.
What happens when the Bank Rate falls to zero? This is where Quantitative Easing comes into play. Quantitative Easing is a complex term used to describe the creation of digital money which is used to push down interest rates offered on loans. Thankfully, you do not need to understand the mechanics of how this works. All a property investor needs to know is that the greater the amount of Quantitative Easing, the lower the cost of borrowing.
Who Sets the UK’S Monetary Policy?
The UK’s monetary policy is decided by the BoE’s Monetary Policy Committee (MPC). Nine eminent members convene eight times a year to determine what action needs to be taken. They discuss and vote upon what overall monetary policy the BoE should pursue.
The details of MPC meetings are published to the public immediately with a breakdown of the decision made and the votes cast.
Why Should Property Investors Care About Monetary Policy?
The decisions and discussions of the MPC directly impact Landlords and property investors. As mentioned, monetary policy is used to control the cost of borrowing with the intention of influencing interest rates. The decisions made by the MPC can directly affect the profitability of many tenancies and strongly influence house prices generally.
What is equally as important for landlords and property investors is the nature of monetary policy itself. It can typically take up to 2 years for monetary policy to have its full effect on the economy. This means that the MPC must be forward looking and their decisions need to take account of what they expect the economy to be like in the future. As such, the Monetary Policy Report can give landlords and property investors the tools and insight they need to make good, prudent decisions.
A good understanding of the current monetary policy outlook can help to provide answers to the following questions:
- What loan-to-value should you take out on a property?
- Should you choose a 2-year or 5-year fixed rate?
- What will you monthly mortgage cost be after your fixed rate ends?
- Should you re-mortgage now or wait?
Whilst nothing is definitive, a strong grasp of the current economic climate and expected future monetary policy can help property investors to make good decisions and, just as importantly, avoid bad ones.
Why Monetary Policy Impacts Landlords
Monetary policy is used to control interest rates and changes to monetary policy can be used to either increase or decrease the cost of borrowing. For landlords and property investors this can directly impact the profitability of the properties they own or choose to buy.
Leverage (borrowing) is one of the key advantages of property investing. It allows investors to increase returns and make their money work harder. If the MPC were to loosen their monetary policy (reduce interest rates) the cost of borrowing will decrease. A lower cost of borrowing means lower interest on mortgages, lower monthly repayments, and hopefully more profitable tenancies.
Many landlords who rely on leverage will face a recurring question of whether or not to refinance (re-mortgage) their properties when the fixed rate ends. Often the decision is determined by whether or not the proposed refinancing will result in lower monthly costs than staying on the new variable rate. If the MPC suggests that interest rates are likely to rise in the near future, locking in a fixed rate might be a sensible option even if it does not immediately make sense at the current interest rates. If the MPC suggests that interest rates are likely to fall in the near future, it might make sense to delay refinancing until they do. The same considerations can be made when considering the term of the mortgage you take out.
How Monetary Policy Impacts House Prices
Monetary policy can affect property prices in a number of different ways. Firstly, decreasing the cost to borrow makes mortgages more affordable to investors and home buyers alike. Lower interest rates can allow people to borrow more. Larger mortgages mean more money to spend when buying a house and thus, upward pressure on house prices. Equally, an increased cost of borrowing can result in higher monthly payments, reducing borrower’s ability to afford mortgage payments. This can cause people to have to sell their current properties or put off buying a new one.
House prices can also be affected by the ‘time value’ of money. Without delving into the detail and concepts behind this, the premise is that £100 today is worth more than £100 in a years’ time. Interest rates and inflation directly impact by how much £100 is discounted in the future. As such, where properties are valued based off their future cashflows (something common in commercial property and general investing), falling interest rates can result in a greater Net Present Value (NPV) today. Therefore, increased property values in the present.
What Does A Property Investor Need to Know About Monetary Policy?
Landlords and property investors do not need to understand every feature and theory of monetary policy. The theory of money can remain the remit of economists and property investors can instead focus on the process of making money. That being said, a high-level grasp of the economic and monetary environment can only be beneficial to landlords and property investors.
Paying heed to interest rate expectations can help inform decisions when refinancing, whilst understanding the more general economic updates that monetary reports provide can help to influence a broader property investment strategy. All a landlord or investor need do is know the direction of travel and how soon policy might change.
Disclaimer: This ‘Landlord Vision’ blog post is produced for general guidance only, and professional advice should be sought before any decision is made. Nothing in this post should be construed as the giving of advice. Individual circumstances can vary and therefore no responsibility can be accepted by the contributors or the publisher, Landlord Vision Ltd, for any action taken, or any decision made to refrain from action, by any readers of this post. All rights reserved. No part of this post may be reproduced or transmitted in any form or by any means. To the fullest extent permitted by law, the contributors and Landlord Vision do not accept liability for any direct, indirect, special, consequential or other losses or damages of whatsoever kind arising from using this post.
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