Hold on, this could get bumpy
Ashley Seager Monday August 8, 2005 The Guardian
You may think that the housing market, whose foundations having been looking increasingly shaky over the past year, would be shored up by last week's interest rate cut from the Bank of England.
After all, you may say, rising interest rates did for the housing market last year and so the cut, the first for two years, must have the opposite effect. If money is cheaper, people might borrow more and start buying property again.
That is a dangerously complacent view. The house price bubble, the biggest this country has ever seen, was pricked last summer and has been losing air ever since. But it has barely begun to deflate in a serious fashion. It seems unlikely that the puncture can be patched up by an interest rate cut or two, let alone the bubble re-inflated, as some estate agents hope.
Let's be clear about this. House prices in Britain were massively overvalued, by as much as 50%, last summer when they finally stopped rising. As they have stood more or less still since then, the extent of that overvaluation has barely fallen. Prices had gone up 200% in the previous seven years even though inflation more generally was running at around 2.5% a year.
As a result house prices are still around six times average salaries, compared to a long-term average of 3.5 times. If prices were to stand still, it would take at least eight years for the long-term relationship to be re-established. It is hard to see that happening.
Since Mervyn King, the Bank of England's governor, warned in June last year that there was a danger of prices falling, prices have either been static or, in the case of London and the south-east, have begun to fall. Sellers are clinging to hopes of high prices, but are only selling if they drop their price.
And buyers are reluctant to buy now because they scent that the ball is back in their court and also because prices are still very high, which means a huge deposit. While an interest rate cut makes a mortgage slightly cheaper, it makes no difference to the size of the deposit required.
Interest rates were cut very sharply in the early 1990s but it took several years for house prices to turn up again.
The current housing market indicators are not universally gloomy, however. There is some evidence that the decline in activity - measured by buyer inquiries and mortgage approvals - may have bottomed out. But it is far from clear that this heralds any kind of upturn. It may just be a pause on the way down.
In fact, as Ed Stansfield at consultancy Capital Economics points out, there is a clear parallel between what has happened to mortgage approvals over the past year and what they did in the early stages of the last housing market crash - a strong fall, a gradual recovery for a while, then a slump. "It is absolutely spooky," he says.
The Royal Institution of Chartered Surveyors' monthly survey of surveyors - one of the most reliable housing market indicators - is still pointing to sharp price falls. And now, the main price indicators from the Nationwide and Halifax are showing annual price inflation slowing rapidly. The Halifax reported on Friday that prices were only 2.3% higher than a year ago, a nine-year low.
Fairly soon, probably in October or November, this annual rate could turn negative. There is no reason for it to stop at zero. Then any lingering pretence that bricks and mortar remain a rock-solid investment will have gone.
This could be a key psychological blow to the housing market. Over the past year, you could hear people saying things like, "My house price may have dipped this month but it is still 10% higher than a year ago."
And the knock-on effects on the economy could be grave. Already household spending has slowed sharply, as has mortgage-equity withdrawal, where people add to their mortgage to spend on other things. This has hit the retail sector hard and has slowed the whole economy down faster than the Bank of England had expected. This is why the Bank cut rates last week. Slower growth leads to slower inflation and its remit is not to let inflation slow too far.
So why should house prices fall? After all, say the optimists, there is no economic recession and no obvious trigger such as a sharp rise in unemployment or a sharp rise in interest rates, especially as they have now been cut. People don't have to move and so will just stay put and wait for prices to pick up.
I am not convinced by that. Prices, as in all markets, are set at the margin. In housing, about 7-8% of the market changes hands every year. Within that are always people who need to sell including, for example, builders of new developments. Recent results from housebuilders show that they have cut their prices 10% or more in some cases to lure in buyers. In private, many house builders are very gloomy.
Moreover, unemployment has started to rise, on the claimant-count measure at least, and employment has fallen slightly. That will not increase confidence in the housing market. And people are still saving very little of their income in historical terms. If people decide to save more, the economy and housing market could weaken further. If they think house prices are falling, they will be reluctant to buy.
To get a broader perspective on the house price bubble, it is worth looking at other countries. Britain's bubble is far from unique. Indeed, it is clear that the wave of interest rate cuts around the world in the wake of the bursting of the dotcom bubble five years ago, which saw shares tumble 50%, created a boom in housing instead.
All across the rich world, with the exception of Germany and Japan, house prices have been booming. The United States, France, Spain and Ireland are just a few of the countries that have seen double-digit property price rises in recent years. The resultant increase in (largely illusory) wealth has been bigger than the dotcom bubble.
And the correction now seems to have started in Britain, Australia and the Netherlands. Prices are still steaming away in France and the US and many other countries, but the warning signs are flashing. Prices in Sydney are down 16% in two years, according to international comparisons done by the Economist. Why shouldn't that happen in London, where prices are already down 3-5% on some measures?
But any way you look at it, it is clear the correction has only just begun.
In Britain the slowdown in consumer spending has occurred with house prices standing still. If and when prices start to fall, there could be trouble for the economy. The Netherlands is stuck in recession after its house price boom turned to bust a few years ago. The Japanese property market has been falling for 14 years since its bubble burst.
And don't be fooled by the apparently modest pace of the price slowdown in Britain over the past year. House prices moves tend to be slow rather than rapid. But once they have started, they gather momentum. Further gradual declines seem the most likely course and that is no bad thing, especially if you are a buyer. People need to be aware that asset prices can go down as well as up.
Rents, meanwhile, are likely to rise as house prices move sideways or downwards, pushing up rental yields from their current lows. A few people may choose to tuck a rental property into one of the new self-invested pension plans to be launched next spring but I doubt that will be enough to encourage a big wave of buying-to-let, which has fallen hugely in popularity this year as hopes of capital gains have faded.
It is, of course, possible that things really are "different this time", as the housing market optimists like to say. But all bubbles in the past have burst, and this one looks no different.
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