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
