Beware complacency over a slow improvement in the housing market Central London is a completely different story. Indeed, it should be thought of as a completely different country, responding to international factors affecting rich, internationally mobile people. But these factors do not figure large in Penge or Neasden, never mind Scunthorpe. Outside central London, it will be difficult for a boom to materialise when real earnings are falling. And the stock of mortgage debt has barely increased over the last year, suggesting that lenders are still cautious. Among both commentators and the public at large, the general view is that as long as prices rise only slowly, everything will be fine. This is far too complacent. The market does not need to get into boom territory for current developments to cause trouble. Even if average house prices rise only slowly, this would still leave the market vulnerable to a sharp correction later, because the rise starts from an already inflated level. Admittedly, estimating a "fair" value for house prices is not a science. But there are some key guides to value. The ratio of average house prices to average earnings is well over its historical average and even above where it got to at the peak of the late 1980s boom. Now, of course, there is nothing sacrosanct about historical averages. Indeed, there are sound reasons why the sustainable level of this ratio is higher than it was. The population has risen considerably and this increase has not been matched by the rate of housebuilding. Moreover, as people get richer they tend to want to spend more of their incomes on property. But it is difficult to explain the entire rise in the ratio by these factors. We all know what has kept house prices up. It is the very low interest rates set by the Bank of England. Not surprisingly, given that mortgage rates are currently at record lows, houses are "affordable"; with a deposit of 20pc, a person on average earnings buying an average house would find themselves paying around 36pc of their take-home pay on mortgage payments. That is below the long-run average of just over 40pc. Mind you, being able to afford a mortgage is only helpful if you can get one in the first place. And that is far from easy for most potential buyers. How should macroeconomic policy react to this situation? The Bank now has the power to require banks to hold more capital against new mortgages. That would make mortgages lending less attractive for the banks, which should reduce the amount they lend. There is no prospect that the Bank will use those powers anytime soon. But it has said that if the market shows definite signs of overheating, it is prepared to use them. Moreover, last week it emerged that the Chancellor will give the power to the Bank to recommend reducing the maximum size of the mortgages which will be eligible for a guarantee. Also, the Bank will be able to recommend to the Treasury that it increases the fees charged to banks for the guarantee. This is sensible. The real challenge for the housing market, though, will come when official interest rates start to rise. Admittedly, that is still some way off - perhaps two years and I think probably even more. But it will come. When it does, the market will have to adjust. There are three ways - a crash of prices; a very long period when they go nowhere so that they become gradually less demanding against average earnings, which steadily rise; or a burst of higher wages which quickly makes housing more affordable, but also leads to higher inflation. None of these is very attractive. That is the price we will all have to pay for stoking up the housing market before it has made full adjustment to previous excesses. Thank goodness there are things to be optimistic about and the economy is picking up. But some aspects of the current economic scene are depressingly familiar. We are supposed to be rebalancing the economy towards investment and exports. Yet, in trying to reduce its budget deficit, the Government initially cut capital spending. Now it is stimulating the economy by boosting the housing market. Meanwhile, last week's balance of payments figures showed a whopping deficit. What a shame that there isn't a way for the Government to get our exports to surge as easily as it can prod the housing market into life.