The Central Bank is concerned that the housing market could be overheating. This worries it for two reasons. The first is that it believes that higher property prices could eventually feed through to an increase in the rate of inflation. And second is the fear that some borrowers could overstretch themselves and run into problems if house prices fall, or interest rates go up.
Judging the seriousness of these problems is not easy. Certainly, property prices are rising rapidly, particularly in popular locations in urban areas such as parts of Dublin and Galway. Also, it is clear that many borrowers are taking out sizeable loans and that the banks and building societies are more than happy to provide them with the cash. The financial institutions argue that they are not being imprudent, but the Central Bank is not convinced and is to write to them next week seeking details of their lending policies.
Are higher property prices posing an inflationary risk? On their own, rises in home values do not feed directly through to a higher rate of inflation. But what is worrying the Central Bank is the fear that rising property values may create a "feel good" factor which will contribute to an excessive rise in consumer spending.
In making this judgment, the bank is relying on instinct, as there is, as yet, no statistical evidence of a pick up in the inflation rate. The February consumer price index will be published next week and will be watched with interest for any signs of pressure on prices. But the bank is correct to urge caution on those taking out loans. EU monetary union - with the promise of stable and low interest rates is not yet a certainty and experience has shown that periods of sharp increases in property prices are often followed by equally sharp declines.
The Central Bank is limited in its policy options. It is correct to write to the financial institutions, but such is the level of competition in the market, that the banks and building societies will be loath to cut lending for fear of losing market share. While its role as regulator might allow it to take certain steps to try to rein in lending growth, in practice the bank is likely to rely on its moral authority to try to persuade the financial institutions to tighten up their lending policies.
The Central Bank's other traditional weapon is higher interest rates. However it is unlikely to increase borrowing costs at the moment for fear of strengthening the pound even further in the ERM band. The most the bank can hope to achieve is to keep interest rates at current levels for as long as possible. Much now depends on the outlook for monetary union. If EMU goes ahead on schedule and Ireland joins, then sharp volatility in interest rates should be avoided and borrowers may see an easing over the next year and a half. However if the monetary union project were to be postponed - which must be judged unlikely, though not impossible - then interest rates could increase and many borrowers would feel the pinch. Both borrowers and lenders should remember that a future of permanently low and stable interest rates inside monetary union is not yet guaranteed and that property prices can fall as well as rise.