WHENEVER I write about the housing market I feel a bit like Tom Jones, with
his army of underwear-throwing fans. On the one hand it is always good to
get a response. On the other, you’re never quite sure what you are going to
get.
Anyway, this is a good moment to take another look at housing. Interest rates
have risen four times and the message from the Bank of England’s inflation
report and last week’s minutes was that they have further to go. Housing
slowdowns of varying intensity have hit America, Spain and Ireland, which to
some is evidence of global bubble about to burst.
Housing is also in the news as a result of Ruth Kelly’s embarrassing
announcement of a delay in the introduction of home information packs (Hips)
– they will now be phased in from August 1. There had been fears Hips would
bring housing activity to a halt. Now, although the government remains
committed, some question whether they will be introduced at all.
So what is happening to Britain’s housing market, and what is going to happen?
When I dropped in at Building Societies Association conference last week, talk
of a UK slowdown was high on the agenda. Societies saw an 8% drop in
mortgage approvals last month compared with a year earlier, the first such
fall since the summer of 2005. Net new advances more than halved between
March and April.
These figures chime with other evidence that higher interest rates may be
starting to affect the market, though these things take time. The Bank noted
that the effective mortgage rate rose by only 0.38 percentage points
following the cumulative 0.75point hike in Bank rate between August and
January.
This was not due to a sudden outbreak of generosity on the part of lenders but
because many borrowers are on fixed rates, on which the average increase was
just 0.04 points. The crunch for them will come on remortgaging.
The recent rise in house prices should be put in perspective. Figures from
Nationwide building society for the first quarter show a phenomenal annual
price rise in Northern Ireland, 57.6%, with Scotland up 15.2% and London
14.3%. But in the Midlands, the north and Wales, house-price inflation has
slowed to between 4% and 6%.
Many factors have led to house prices rising, more than trebling in fact,
since May 1997. They include rising employment, rising numbers of
households, limited new housing supply and the emergence of buy-to-let. As
people’s confidence in conventional pensions has declined, so their belief
in property has increased.
It is also the case, both in Britain and globally, that the fall in long-term
real interest rates – the gap between inflation and interest rates on
government bonds – has helped support property.
Much the most important factor, however, has been the short-term interest rate
set by the Bank. Here, there is a coherent story about the various phases of
the current house-price boom.
The first phase was from the mid1990s to 2000-1. The sharp fall in prices at
the end of the 1980s and early 1990s had pushed them to very low levels in
relation to rents, other assets and incomes. This, combined with the
realisation that lower interest rates were here to stay, produced a strong
rise.
By 2000-1, though house prices were still below their long-term trend, the
boom had begun to fade. Then, in response to the bursting of the dotcom
bubble, September 11 and the start of the Iraq war – all global events – the
Bank cut rates, taking them all the way down to 3.5% during 2003. These cuts
produced the boom’s second phase, from late 2001 to mid2004.
Then, however, the Bank switched into tightening mode, raising Bank rate five
times between November 2003 and August 2004. The results of this on the
housing market were significant, producing the famous 2004-5 pause in
prices. I’m often characterised as a cockeyed optimist, but I expected that
pause to continue.
Why did it not do so? Either the fact that the Bank stopped hiking, or its
single rate cut in August 2005, or both, stimulated the market, giving us
today’s phase of the boom. The Bank almost brought the housing market down
to earth but did not quite follow through, a bit like the allies and their
failure to get Saddam Hussein in the first Gulf war.
If I’m right that a housing slowdown is in the air, then what we will see in
the coming months is a sharp slowdown in house-price inflation, in direct
response to the interest-rate hikes we have seen, and in prospect.
The difference between now and then is that global pressures for the Bank to
cut rates are hard to see. The Bank has presided over high house-price
inflation in order to meet its target for consumer price inflation. The boot
is on the other foot. Because that target is paramount it will not mind,
within reason, what happens to house prices to achieve it.
Does that mean a house-price crash? Not in my view. House-price crashes are
rare in Britain and have never occurred in the absence of recession. The
global economic environment is strong, as is the UK economy. I would see
something like the 2004-5 picture of flat or modestly rising prices, but
lasting far longer.
Housing-market bears usually argue that such is the overvaluation of housing,
50% on conventional (and I would argue irrelevant) measures like the
house-price /earnings ratio, that prices have to fall. However, a new
analysis by Lehman Brothers, which has reworked its model of the UK housing
market, suggests a more modest overvaluation of 15%.
Several factors have prompted Lehman’s reassessment, including the narrowing
spread between official interest rates and mortgage rates, and the
credibility gains achieved by Bank independence. The firm has also looked in
detail at credit conditions round Britain. Where loan-to-income ratios are
high, as in London and southeast England, loan-to-value ratios are typically
lower than in the north, indicating that southerners usually have plenty of
equity to put into a property purchase.
Lehman’s conclusion, like mine, is that prices will slow going into next year
but not collapse. And 15% is much easier to work off, through a period of
flat house prices and rising incomes, than 50%.
What could go wrong? Each time the Bank has lifted the veil on interest rates
recently it has raised the level at which it expects them to peak. Oil and
food prices present the biggest risk to its view that inflation will soon be
back to 2% but so, according to the CBI, is the fact that manufacturers’
price expectations are at a 12-year high.
The Bank, with its tougher language, is getting things back under control.
House prices have always been most vulnerable when the authorities have lost
control of monetary policy.
PS: Last week I did a talk at Chatham House on my China-India book,
The Dragon and the Elephant, and a launch at the Institute of Economic
Affairs. There is a lot of expertise on the subject out there.
One frequent question was whether the Chinese economy will crash. China’s
growth topped 11% in the first quarter and the stock market is enjoying a
Klondike boom, prompting crash warnings from Alan Greenspan and the OECD.
Nine days ago the authorities raised interest rates, increased reserve
requirements and allowed the currency more slack.
The economy is growing too rapidly for comfort and the authorities are
concerned by feverish stock-market activity. But 11% growth, while heady, is
not too far above China’s 9.5% average of the past three decades. The aim is
to apply the brakes gently, not bring things to a juddering halt.
As for the stock market, it is highly unlikely to bring the economy down. The
link between stock-market falls and economic activity is pretty tenuous in
Britain. In China, where the vast majority of businesses are not quoted, it
is even thinner. The stock market may tumble but the economy will merely
slow.
Meanwhile, 100 teachers of Mandarin are being recruited from China to teach
in English schools. China has invested $3 billion in Blackstone, the
private-equity group, as part of a $200 billion plan to diversify its $1,200
billion of currency reserves into higher-yielding assets. We’ll hear a lot
more of this.
david.smith@sunday-times.co.uk
British Homes: Far too small, far too "Cookie-cutter" and far too over-valued...Result: Particular buyers - good!
pat, FL, USA,
For the last two years the only place that has seen house prices rise in England has been London. The stat's for the rest of the country are only affected by the rise's in London. So if they were to fall it is London that will be the one most effected. Especialy where I live near York house prices have not moved for two years even though they say it has gone up 5 or 6% over the last two years.
And for the stockmarket well I can only see strength continue in it due to good economy probably for the next year or two. But it will be rocky, only for the strong minded.
Alex Hoyland, Easingwold, England
The FTSE is back to its 2000 levels (no thanks to Gordon the Bandit), Sterling's high (except against the Euro), and UK real estate is surely peaking. Time to take the money and run. Hard to imagine a better time to sell out and retire and/or seek your fortune overseas. But as you draw up your short list, consider a location where you as a Brit will be in demand. Thanks to the Internet, the initial research can be done without leaving home
Andrew Milner, Yokohama, Kanagawa
Oh dear... Without house price growth factored into the UK's overall growth figures the next set of growth statistics should at long last reveal the fragility of the UK economy.
Dick, Aberdeenshire,
I don't see how the independence of the Bank of England can be considered to have been a success when they have presided over a doubling/tripling of house prices - such rampant asset inflation seems like incompetence on a grand scale.
MS, Stoke, England
"House-price crashes are rare in Britain and have never occurred in the absence of recession."
That's because land price crashes cause recessions. Land (ie house) price crashes are not rare, they work on a long cycle which is only disrupted by major events such as world war.
Andrew, London,
It's brilliant!!!
With all these people going bust (1 million CCJ's expected this year, 5% of households) there's going to be loads of repossesions and cheap, cheap auction prices.
The muppets who listened to the "property experts" (usually estate agents or mortgage brokers) and then over borrowed or MEW'ed (that's effectively buying your own house off the bank at the overinflated prices) are going to give their houses to the smart people like me!!!
See you all at the auction house, take care!
Jon Silverston, brussels, belgium
Interesting comment above as to whether or not the MPC has the guts to act like a proper central bank and tighten up monetary policy and pop the property bubble. The problem is that the property price spiral has become so central to the UK economy and growth that in its absence the UK would not only enter a recession but there would also be a collapse of asset price values. We saw that in 2004/2005 when only quite moderate rises in interest rates triggered a downturn in property prices and a consequent contraction in economic activity - this is the object of tightening monetary policy by the way. There followed squeals of outrage, and the MPC prompty 'bottled' it and lowered interest rates again. So the show went on. What will happen this time? Will the MPC show its mettle and political independence and administer the medicine? Moot point. Per contra if it doesn't houses will rise to an impossible price level and the bubble will pop by itself. Rock and a hard place? You bet!
F V Lee, London, UK
In the Seventies interest rate rose to 10% to 17% because of the petro recession - as we are even more dependent on oil everything should be more mirrored to past events
I think history will repeat itself and we wil have a new speeded up round of interest rate rises
I will assume not wanting to put into place quick movements upward in interest rates like in the past has allowed quarterly rises and half yearly rises to be played over time spans of the same length as in the past.
What about politics,,its not long to the next election,, who is theone person whom wants to win ,, mr Brown.
What implicatons will this have on interest rates,, March 2008 the USA has said is the first pullout Iraq, so the war is being fixed, so why not fix interest rates for the election.
Interest rates fixed for an election,,,have we heard this before,, looks like a bull run on stocks is possible again, but then there is China to consider and its forcast mini crash yet to arrive
Nicholas Iles, Oswestry, Shropshire
A greater and more imminent threat may be seen in the number of shop fronts that are now boarded up in London and the South East. What is this telling us?
Ashok, London, UK
"50% on conventional (and I would argue irrelevant) measures like the house-price /earnings ratio"... of course, it is different this time!
Michele, Richmond, Surrey
I think it's time to revive the perjorative "inflation nutter".
Oil prices rise, that affects the inflation figures and causes a clamour for raising interest rates. That price rise is DEFLATIONARY at first round because it sucks money out of the economy. The second round effects, if any, are inflationary - I need a rise because it's more costly getting to work. Even that is only inflationary if the employer manages to pay for it by raising prices.
Much of the RPI and CPI is made up of primary (deflationary) cost increases. The bank admits as much.
Much of the increase in earnings is related to pay in the City. There is a limit to how much these people will spend on bananas or milk from Tesco. Core inflation.
In the late eighties and early nineties, most of the country could not see the inflation the Bank worried about. They were being squeezed by costs they could not pass on and losing their jobs. That wasn't inflation, it was deflation. It was stupid. It was worse.
Peter Dunford, Bournemouth, UK
House-price crashes ... have never occurred in the absence of recession"
Let's consider the reality:
House price crashes trigger recessions- so no wonder they go together. Mr. Smith has the horse on the wrong side of the cart
drbubb, Hong Kong & London, China & UK
Here we go again on the - " its different here bandwagon. "
Surely elementary arithmetic will reveal that if something is already expensive increasing interest rates on the loan you need to buy it will make it even more expensive and reduce the pool of buyers. That is what has happened in America, and that is what is going to led to a house price crash here as surely as night follows day. If what you are saying is right then the prices of bonds and other assets should not fall when interest rates go up. They should slow down just like tech stocks in 2000.
anthony, London, England
The mini housing boom in 2005 - 2006 is the result of the foolish decision by the external members of the MPC in August 2005 to reduce interest rates by 0.25%. Comments in the tabloids that interest rates were coming down assisted and by March 2006, the mini housing boom was in full swing. House prices will slow down later this year because of the recent interest rates. The question is whether the current MPC have the guts to keep monetary policy tight or will they lower interest rates if house prices fall too much. Governments and central bankers are foolish. When a bubble bursts they lower interest rates quickly and this in turn creates another bubble. In 1987 the Federal Reserve Bank lowered interest rates because Stock markets crashed 30%. That created a real estate boom, interest rates were hiked in 1989 and 1990 and the US tipped into recession in 1991 - 1992. Something similar happened after the FRB lowered interest rates to below 2% in response to 9/11.
John Fernandez, London, UK
the boe is to blame for holding rates far to low for far to long and still hold rates far to low
mike keary, paisley, scotland
Undoubtably the BOE's August rate cut played its part in igniting the housing market, but so did media economists, such as Dave Smith, who were quick to pedal the probability of "more cuts to follow" ( regardless of the fact that the Bank Governor had been opposed to the August cut).
For example Mr Smith (Sunday Times 21/8/2005) quote: "looking into next year, it would be an odd interest rate cycle that featured just one cut, the probability is for more"
or this piece of positivity on the 14/8/2005 quote:" despite the Banks cautious message last week, this months rate cut will not be the last"
or Sunday Times 23/10/05, quote: "next year, when inflation is falling and growth continues quite weak, will provide ample opportunity for a rate cut or two"
Ben
Benjamin Coulston, Bournemouth, UK
David,
You are right to say that oil is THE risk. With the 3 biggest oil fields in the world in decline and ever increasing demand the view looking forward is not rosy.
Already there is a worldwide tightening of oil supplies and soon oil will be sold to the highest bidders. We are beginning to see evidence of this with third world countries having to ration energy supplies. OPEC have started closing the oil tap and reducing supply - whether this is voluntary remains to be seen.
This year we will see oil prices reach $80+. We can only foresee higher interest rates and higher inflation.
Look out property!
Paul Price, Warrington, England
China's stock market is in its final parabolic stage. The frequency of new share trading accounts being opened in china virtually doubles every week.
Yes, most companies are not quoted but the stock market represents the pinacle of the fever pitch of speculative activity and the impact of the enivitable crash of the chinease stock market THIS year ! And it will crash this year there is little doubt of that, given the parabolic nature. Then the impact is likely be pretty severe on the chinease economy, especially given the near immediate ripple effect across the world financial markets.
In Feb we got a small taste of what to expect.
1929 anyone ?
UK interest rates are expected to peak in September, but the sentiment for higher interest rates will continue later into the year, which will as yuor article suggests prick the UK housing bubble, which has gone on for far longer than anyone could have imagined it could, and therefore even the bears have more or less given up !
Nadeem Walayat, Sheffield, UK
http://www.housepricecrash.co.uk/
This site will become legendary.
Tom Jones, England,
It's too late, David - you have established your reputation as a "cockeyed optimist" and this reputation is well earned. On your blog, back in November 2006, I set out the three phases when I explained
“The current surge in demand must leave a vacuum in its wake, as people find they have overstretched themselves and others become more cautious. That's when the bubble will burst - when the default position changes from 'pile in regardless' to 'don't touch it with a barge-pole'. In the meantime we shall get the 'wait and see' stage, but the slow-down from this (unless 'cured' by another rate cut, which seems unlikely) will lead to a cooling in demand and some fall in prices, then we move into phase 3 and it's down-hill all the way.”
You pooh-poohed this view then, but I would suggest that we are just entering phase 2. Isn’t it time you just accepted the inevitable, rather than keep on saying it wont happen?
Tony Marshall, Southampton,
With reference to the PS in this Economic Outlook , this week's (24/05/2007) Economist newspaper devotes its regular "Economic Focus" column to an excellent analysis entitled "The Great Wall of Money" on China's predicament. Both Dvid Smith and the Economist concur that "China's economy may be less vulnerable to a bursting of the stockmarket bubble than it appears" at first glance.
The link to the Economist article is:
http://www.economist.com/finance/displaystory.cfm?story_id=9225696
Occam, Solihull, UK
Congratulations David,
You have made the first page on http://www.housepricecrash.co.uk/
Michele, Richmond, Surrey
Your analysis of the housing market is a sober, rational reflection using the perspective of history. Does this not ignore two familiar forces that don’t operate rationally?
One, the herd instinct. A 15% fall may not be much after recent gains but how will that sit with the “A Place in the Sun” and “Property Ladder” mentality that is so pervasive and so heavily promoted.
Two, the over-exuberant bank lending. The unexpected surge in price after the pause in 2004/5 you mention can be explained by this factor alone.
Inflation is the key. You wrote in April 8, 2007, “The Centre for Economics and Business Research says consumer-price inflation, now 2.8%, will be down to 1.9% by July. …that forecast looks quite secure.”.
Is this still your view?
Peter Kellow, Lesneven , FRANCE