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Will Osborne blushes be spared by UK economy's new clothes?

Watching the main characters in the unfolding UK economic drama has brought back memories of an old favourite Ladybird book, 'The Emperor's New Clothes'.

Our political leaders are, it seems, becoming more confident by the day about proclaiming the virtues of their grand economic plan. Only last week, Prime Minister David Cameron tweeted: "More proof that our long-term economic plan is working, as the @britishchambers upgrades its growth forecast for 2014."

It is no great surprise that he was keen to claim further credit for the UK's economic recovery, regardless of the fact that it has been excruciatingly protracted and painful for many. But his view of what constitutes "long term" is at the very least baffling, and perhaps just plain astonishing.

Last spring, with George Osborne's March 2011 vision of "a Britain carried aloft by the march of the makers" having failed to materialise, the Chancellor and his Coalition colleagues changed tack with major moves to inflate the UK housing market ahead of the 2015 General Election.

As anyone with even a vague knowledge of UK economic history could have told you, that was not going to take a long time to cause a problem.

And so it has proved. This short-term measure is, little more than a year later, causing the alarm bells to ring.

Last month, Bank of England Governor Mark Carney cited the housing market as the biggest domestic risk to the UK's financial stability.

And he has certainly not been alone in highlighting the dangers as house prices have surged. With more and more warning signals about the housing market emerging, Royal Bank of Scotland this week joined fellow state-backed rival Lloyds Banking Group in tightening mortgage lending criteria.

There has, rightly, been much focus on the particular boom in house prices in London and south-east England but there are other geographical pockets of the UK in which the residential property market is starting to look a bit warm, particularly given the eventual inevitability of rises in base rates.

A survey published yesterday by mortgage lender Halifax, part of Lloyds Banking Group, showed the biggest monthly jump in UK house prices in 11 years in May. The Halifax survey showed that the average UK house price leapt by 3.9% per cent month-on-month, on a seasonally adjusted basis, in May.

Mr Carney reiterated last month that monetary policy was the last line of defence in dealing with matters of financial stability and that the Financial Policy Committee would act first to cool the housing market, if it thought that such action were required.

The Bank of England's Monetary Policy Committee yesterday held UK base rates at 0.5 per cent, where they have been since March 2009, as the Halifax survey provided yet more evidence of the worryingly unbalanced nature of the economic recovery.

That said, it is perhaps not surprising the Bank of England is wary of pulling the interest-rate trigger too early.

On Tuesday, the chief executive of the UK's so-called "bad bank", which is winding down the loans of Northern Rock and Bradford & Bingley, painted a fairly scary picture of what might be in store even if base rates were to rise to a level still way below their historic norms.

Richard Banks, chief executive of this state-backed UK Asset Resolution operation, said it anticipated that a rise in base rates of one percentage point, to 1.5%, could put another 22,000 customers into arrears.

You get the feeling that a lot of people, often through little choice of their own at a time when the economic backdrop remains fairly grim for many, will find themselves painfully exposed when base rates do start to rise.

Brian Ashcroft, emeritus professor of economics at the University of Strathclyde, expressed concerns last autumn that some households seemed to be having to have recourse to cash generators, payday loan companies, and pawnbrokers.

He noted last October that new car purchases were up but expressed concern about a "far greater proportion" of these being financed by credit, with lease arrangements also common. He said this would be fine if household debt were low but highlighted the fact that it was high.

A survey published this week by credit report provider Creditsafe found that car-leasing firms had suffered increasing incidences of late payments or default in the last 12 months. More than three-quarters of dedicated car-leasing firms have seen an increase in payment issues, with nearly one-third of them losing money in this period as a result of clients entering insolvency or declaring bankruptcy, the survey found.

Like in the Hans Christian Andersen fairy tale, it is only a matter of time before the UK economy's new clothes are exposed for what they are: a very ill-fitting ensemble hastily stitched together by Mr Osborne and his colleagues to hide the Coalition's embarrassment.

The big question is whether or not this particular revelation happens before next year's General Election.

Given increasing potential for trouble in the housing market and alarming signs about the inability of some people to service debts even with base rates at or near rock-bottom, it will be a closer call than might have been thought last spring, when Mr Osborne plumped for the fast but risky option of aiming to boost sentiment among the electorate by pushing residential property prices higher. Just how close a call it will be is likely to depend on how long Mr Carney and his MPC colleagues feel they can hold off from raising interest rates.

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