The Bank of England is responsible for setting the Bank Rate at a level which keeps national inflation within limits set by the government. The snag is that during boom periods when inflation is rising, the boom favours the national prosperity hot spots, mainly the South East of England. As the last Governor of the Bank of England famously pointed out, during such times, it is necessary for the less prosperous regions of the UK to accept a high Bank Rate for the greater long term good of all.

Regional Bank Rates, which vary according to local inflation would not be a viable solution because investors would simply borrow money in regions where interest rates were low and invest the money in regions where the interest rates were high. There is however one exception to this economic rule: Because land and permanent buildings are immobile, effective interest rates on loans to purchase land and property could be adjusted to meet local conditions.

The Bank of England should be given the power to set a "Surcharge Interest Rate" (SIR) which is added to the prevailing mortgage rate set by the lender, when house price inflation is high. So, for example, if the current SIR was set at one percent, the lender would pay at their current loan rate of interest to the lender, plus an additional one percent.

However, unlike the present system where mortgage payers see nothing in return for making higher interest payments when interest rates go up, the additional SIR payments would be paid into a bonded long term savings account and would earn interest. At some point in the life of the mortgage repayment, the mortgage payers savings in their bonded savings account will equal their outstanding mortgage dept. At this point, their savings could be used to pay off the remaining mortgage dept early.
During periods when the housing markets are stagnant, the Bank of England could allow mortgage lenders to withdraw funds from their bonded savings account to help pay for costs associated with moving to a new home or improving their existing property. They would also be allowed to withdraw from their account, if they fell on hard times and risked losing their property because they had defaulted on mortgage repayments.
After the system has bedding in for a few years, economists will have gained sufficient knowledge to fine tune it. At this stage, the regional benefits would be gained. Regional authorities could be granted the power to modify the nationally set SIR to cope with local circumstances. Initially The Bank of England may restrict the regional flexibility to (say) a modest 0.2%. But as confidence and experience grew, the Bank may allow regional authorities the right to make larger adjustments. There is no reason why these local adjustments need to be fixed for the whole of a region. In principle, they could be set at a micro-level, for example according to post code.

What would happen if Britain decided to adopt the Euro?

In this case the Bank of England would lose the right to set the Bank Rate but it would still retain the right to set the additional Surcharge Interest Rate. This would help decouple the British housing market from swings in the wider European non-housing markets. If other national governments within the Euro zone chose to adopt the SIR concept, then the whole of the Euro zone would benefit because the problems caused by a "One size fits all" interest rate for the Euro zone would be reduced.

Would existing borrowers have to open a bonded savings account?

No. House buyers only bring inflation into the market at the time of purchase. For the scheme to be fully effective, it will only be necessary for bonded savings accounts to be opened when a new mortgage agreement is entered into.

Is the surcharge interest rate likely to be a significant burden for borrowers?

Probably not. Current house price inflation is stoked up by purchasers who feel pressurised into buying a new property, before the selling price exceeds their means. Our proposal would have a long term calming effect on the market, taking away the pressure on potential house buyers to purchase early. This in turn would reduce the need for a high surcharge interest rate.