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After the post credit crunch recovery, UK house prices have fallen for the first time in several months. The Nationwide index   suggests the quarterly rate of house price growth dropped from 2.2 per cent per quarter in the three months to December 2009 to 1.6 and 1.8 per cent in the first and second quarters of this year. In a different survey the Royal Institution of Chartered Surveyors RICS found a net -8% of members found prices were falling, this figure is consistent with falling house prices of 2%.

The set back to house prices comes as

• Increase in number of sellers following improvement in prices from worst of slump
• Increase in number of sellers following abolishment of home information packs.
• Buyers being put off by gloomy economic outlook. Prospects of spending cuts, job losses and wage freezes combined with higher inflation are making people more nervous about buying a house.
• First prospects of higher interest rates as inflation continues to be above target with rising commodity prices and VAT potentially pushing it higher.

Some of the above factors are fairly short term. Long term factors, still leave us with the relative shortage of housing, but, also a relatively expensive long term average of house prices to income.

The slowdown in growth of house prices, will come as small relief to the first time home buyer. Today the Nationwide published figures showing just how expensive it was to get on the property ladder these days.

The average deposit by first time buyers is now £26,422 for a home 25 years ago it was  £1,321.

For the average buyer the expected deposit is £35,614 towards the £142,457 cost of a home today.

Related

• First time buyer deposits

Predicting house prices in the UK has become so unpredictable, many analysts are increasingly reluctant to give any predictions for more than six months hence. Nevertheless, if you are willing to stick your neck out and make a strong prediction, it is a good way to get news coverage. Any dire prediction of house prices is usually gobbled up by the media and the home-owning society that is the UK.

Capital Economics, the consultancy led by Roger Bootle, expects house prices to fall 5pc this year, and 10pc in each of 2011 and 2012.

They base their predictions on:

Why House Prices Will Fall

• Number of sellers is starting to exceed buyers, putting downward pressure on prices.
• Interest rates, currently at record lows, are likely to be rising in 2011 and 2012. This will come as a shock to homeowners who have got used to record low mortgage rates.
• Fiscal Squeeze and dangers of double dip recession. The government have announced plans to cut spending from 2011. This will lead to job losses in the public sector and negatively impact on economic growth. With unemployment still very high this will lead to more homeowners struggling to pay and so will put property on the market.
• House prices are still overvalued by long term data such as house price to incomes ratios.
• New criteria for mortgages makes it much harder to get. New home owners are increasingly have to save a larger % of their house as a deposit. (though there are some promising signs of a thaw in mortgage conditions. Though I feel if house prices were to reverse, banks would return to being risk averse and be reluctant to lend without large deposits.

It is certainly a grim forecast, and there is sound reasoning to support such as scenario. It would also mean the UK following the trend set by US and EU countries such as Spain.

Yet, it may still be worth bearing in mind.

Why House prices may not Fall

• The worst of the recession may be over. It is hard to see a recovery as being anything other than slow. However, at 2.5 million unemployment may have peaked, and could slower recover, as long as recession doesn’t continue.
• Low Interest rates may remain. Given the fiscal squeeze, it is more likely the Bank of England will be able to keep interest rates at record lows.
• A rise in base rates may affect mortgage rates less than expected. With base rates falling to 0.5%, many banks failed to pass the base rate cut onto consumers, preferring to increase their profit margin and encourage savings. If base rates did rise, the impact on mortgage rates would certainly be less.
• The number of sellers may fall if house prices fall. We are certainly not going to have a boom in house supply over next couple of years.

Related

• Historical house prices UK
• Housing Market at Capital economics

UK Base Rates

Interest rates have fallen to a a record low because the economy has experienced its deepest recession since the 1930s.

The Bank of England have kept interest rates at 0.5% since March 2009

Factors which will keep interest rates close to Zero in the future.

• Depth of recession and scale of fall in GDP
• Predicted rise in UK unemployment close to 3 million. Labour force survey gives unemployment of 2.5 million, but, this hides some underemployment (e.g. working part time)
• Budget Deficit rising to 12% of GDP means the government is under pressure to improve fiscal position. This will require higher taxes and lower spending. The government’s fiscal stance and promise to cut spending and public sector jobs from 2011 could damage recovery and is deflationary. Therefore as taxes rise and spending falls, it is more likely interest rates will stay low.
• In 2010, there has been temporary rise in inflation due to rising oil prices and tax rises, but, this does not reflect a fundamental increase in inflationary pressures. The underlying state of the economy means there is a lot of spare capacity and little inflationary pressure. This is one of the main factors which will enable interest rates to remain very low.
• UK housing market has shown signs of uncertainty. House prices rose in 2009 and 2010, but in late 2010 and 2011, we could see a further fall or at least stagnation in prices. see: will house prices fall again?
• Given this gloomy outlook for the UK economy, the Bank of England are forecasting low inflation and low interest rates in 2010 and 2011.

Graph showing Interest Rate Predictions

Bank of England Interest Rate Forecasts

Source: Bank of England latest inflation report [link

This suggests many analysts believe official interest rates could stay at 0.5% during 2010.

I believe it is hard to see interest rates rising before end of 2010.

Factors which will push up Interest Rates

• Scale of Quantitative easing (increasing money supply) increases potential for future inflation. As inflation rises, interest rates could rise sharply. However, the impact of quantitative easing has not been fully understood. Broad money growth still shows slow growth. It is likely quantitative easing will be brought to a halt soon.
• As economy recovers, the historic low interest rates could rise to prevent inflation, which has proved more persistent than expected.
• Rates of 0.5% are exceptionally low. At this rate there is a danger of distorting economic activity.

The forecast for interest rates depends on how strong and robust the economy recovery is At the moment, economic conditions are conducive to low rates for several reasons.

• Weak housing market
• ongoing credit crunch and reluctance to lend by banks
• Negative economic growth in 2009, and relatively weak growth or 2010.
• rising unemployment – over 2.5 milliion
• Credit crisis reducing availability of credit

Factors Influencing interest rates in 2010

• Real interest rates are actually negative. Real interest rates are (Nominal interest rates – inflation) = 0.5% – 3% = -2.5%.
• Sub Prime Mortgage Crisis - The effects of the mortgage sub prime crisis are still being felt in the UK, in particular there is a shortage of mortgage credit. The main effect of the sub prime mortgage problems are to make mortgage lenders less willing to give risky loans. It has also affected consumer confidence. The effect of these two factors are to reduce house price growth and consumer spending. This reduces inflationary pressures and makes it easier to enable interest rate cuts.

Fixed Interest Rate Predictions

Despite base rates staying at 0.5%, fixed rate mortgage deals have not reflected the low interest rates. The Bank of England’s figures suggest the average 2 year fixed rate deal climbed to 4.46 per cent during July. Yet, with forecasts for interest rates to remain close to 0%, this suggest the banks are increasing their profit margins. They shouldn’t really rise more, but, weak competition is pushing fixed rate mortgages slowly up.

Predictions for US Interest Rates

As for the US, interest rates have already been cut to 0% – 0.25%, but, this may be insufficient to stave off the problems arising from the US Housing Market. However, with rates at 0.25% there is little more that they can do. Although the economy shows signs of tentative recovery, base rates are likely to remain low for a while.

See also:

• Difficulties with predicting interest rates
• Interest rates explained

Proposed government spending cuts, could reverse recent house price growth.

Firstly, the rise in house prices has taken many by surprise it has been based on weak fundamentals with only a limited rise in demand. A knock to economic growth could push back overvalued house prices.

The good news is that a recent forecast for UK growth by OBR suggested the UK will expand by just over 2% a year. This is not spectacular growth, but, will help to maintain more stability and reduce unemployment. (Growth rates UK)

However, the concern is that a combination of fiscal austerity and a European wide recession could lead to lower growth in the UK and if things turned really bad we could have a double dip recession.

It means that the prospects for interest rates are likely to remain at 0.5% for a considerable time. Despite inflation exceeding governments target, there is a need for a loose monetary policy to offset the fiscal deflation. Prolonged low interest rates will continue to be good news for homeowners – presuming they can get access to cheap mortgages.

According to the Nationwide survey, UK house prices are just 10% below their 2007 peak. In May 2010, house prices are £169,162. The annual house price inflation is running at 9.8%.

On face value this seems strange given that:

• Unemployment has risen to over 2.5 million (highest since 1994). Arguably this is much disguised unemployment too
• Serious credit crunch in banking sector, making mortgages much more scarce than in 2007.
• House price to income ratios still above long term averages, and almost double similar ratios in the US, where house prices have fallen much more considerably.

However, the Halifax survey of house prices has shown two months of falling house prices as homeowners take advantage of rise in prices to sell.

Also, the forecast for future house prices is more uncertain.

Interest rates are unlikely to rise in near future, as government pursue deflationary fiscal policy to reduce deficit. However, with inflation at 3.7% and interest rates at 0.5%, they may well start to rise next year.

Uncertainty over nature of economic recovery. With unemployment still rising and the likelyhood of public sector job cuts, unemployment may continue to rise leading to more repossessions.

Housing Demand remains thin as potential first time buyers struggle to save necessary deposit.

It comes back to the old story of the UK housing market – shortage of houses for sale, keep house prices high on thin volumes.

In such a climate, there is the likelyhood of house prices struggling to maintain recent gains.

• Long term forecasts for UK housing Market
• UK Housing Market

The OECD has produced a report suggesting interest rates in the UK may have to rise to 3.5% by the end of 2011. They argue that rising inflation (3.7%) and improved prospects for growth mean the Bank may have to act soon in order to prevent inflationary pressure. They argue rates will have to rise by end of the year at the latest in order to maintain credibility.

“The gradual drift up of some measures of inflation expectations implies a need to increase interest rates earlier than previously thought and no later than the last quarter of 2010.” (UK to raise rates)

However, I don’t agree with the OECD report, nor do the Bank of England.

• The spike in inflation is driven by short term factors such as rising petrol and food prices. (remember the oil price induced inflation spike of 5% just before the 2008 recession.
• The OECD have improved the UK’s growth prospects but global growth prospects still look shaky due to problems in Europe and the continued weakness of banking sector.
• Fiscal Policies. The government are committed to making a dint in the size of government borrowing. This will involve higher taxes and cuts in spending. Wage freezes and spending cuts will all help to reduce aggregate demand and economic growth. Therefore, with fiscal tightening it is important monetary policy remains loose to boost spending.
• The US, Europe and Japan all face very low inflation rates with prospect of deflation, if recovery isn’t boosted.

2011 is still a long way off, and it is hard to make predictions for the state of growth, inflation and interest rates. We hope, growth will be sufficiently strong in 2011 to allow some interest rate rises. But, at the moment, there is no pressing need to raise rates because of the high unemployment, fragile recovery and fiscal changes.

Related

• Inflation fears – are they justified?

It’s a bizarre situation when in the aftermath of a prolonged recession, UK house prices manage to increase 10%, despite being fundamentally overvalued.

Rising house prices do have certain benefits, especially in the short run. The rise in house prices creates a positive wealth effect encourage householders to spend. Falling house prices would have prolonged the depression in consumer spending. The rise in house prices will also be welcomed by a fragile banking sector worrying about the combined effect of negative equity and home repossessions. But, although the rise in house prices gives a short term benefit. In the longer term, overvalued house prices present various problems.

• Rising House prices have a history of encouraging reckless borrowing and householders to overstretch themselves. Rising house prices was a significant factor in encouraging a rise in personal borrowing which is now unravelling. At the moment, there may seem little threat of a potential repeat of this. But, if house prices continue to rise, it could again destabilise the incentives to save and borrow.
• Inequality. Rising house prices is simply good news for those fortunate enough to own a house and bad news for those who don’t. It is very difficult for young first time buyers to get on the property ladder. Effectively we have a property market with very little fluidity. Unless you have help from your parents, the options of buying a house are very limited.
• Overvalued. As we mentioned in a previous post, house price to income ratios are still overvalued. When house prices are overvalued there is always the threat of a correction and a fall in house prices which is destabilising to homeowners and the economy. For example, a rise in interest rates or house building programme could cause house prices to fall. What is needed is a period of stability, not volatility.
• Rising House Prices Caused by Shortage of Houses. The rise in house prices does not reflect an underlying strength in the economy and amongst homebuyers – it is more a reflection of the shortage of supply. Prices are being squeezed higher because of limited supply. This means that house price rises are less sustainable.
• Lower Geographical Immobility. Rising house prices makes it more difficult to move. This means it is harder for people to move around the country – especially to hotspots like London.

Historical house prices

Stuck on the wrong side of the Atlantic waiting for a flight home, I’m just waiting for a Daily Mail headline ‘Volcano to lead to House Price Crash’

Volcanoes aside, the remarkable feature of 2010 is the resilience of house prices in the UK, even though they are still relatively overvalued on many criteria. House prices are now around 9% higher than last year

According to the Economist survey April 15th, house prices in the UK are still 31% overvalued. In Britain the house price-to-rent ratio still outstrips its long-term average by nearly a third. Economist survey of overvalued houses

This contrasts with the US, where house prices are now 2% below their ‘fair value’. This reflects a long period of house price falls.

A simple explanation is the surplus of housing stock in the US compared to the UK, where there was never a boom in house builds.

It is not the only factor, in the UK home repossessions have been less severe than expected. Undoubtedly helped by low interest rates, and banks reluctant to enforce repossession, many have been able to keep their houses when it could easily have been repossessed.

However, with inflation creeping above the governments target (CPI inflation now 3.4%), the prospect of low interest rates will not remain.

However, it could be worse, according to the Economist house prices in Spain are 50% overvalued, and they have a huge surplus of housing stock. Spain also faces prospect of deflation or very low inflation because it is in EURO and cannot maintain independent monetary policy. They could face a long period of falling house prices which will only worsen their economic situation.

To an outsider, the budget sounded quite promising – a few tax rises, a few tax cuts. Promises of ‘efficiency savings’ – and the tax on bank bonuses gaining £2bn more than expected. A casual glance at the speech may give the misleading impression the economy is not doing too bad. – Well that is if you missed the statistics about GDP and government borrowing. The twin threat of a weak recovery and higher government borrowing gives any chancellor an unenviable task of trying to reduce borrowing whilst at the same time maintaining the strong rate of growth that is necessary to help reduce the cyclical deficit.

The decision to raise the threshold on stamp duty form £125,000 to £250,000 is good news for those hoping to buy a house. Though given the difficulties in raising a deposit in the new mortgage climate, it is hardly going to cause a stampede into the market. It may just help maintain the recent house price gains.

One thing is fairly certain and that is the prospect of short term increases in interest rates are fairly low. This month, inflation fell back to 3%. Despite volatile factors like rising oil prices, the impact of GDP falling by 6% is to create spare capacity and reduce inflationary pressures.

The government hasn’t wanted to commit to spending cuts. But, there will be need to be some fiscal tightening after the election. With the deflationary impact of higher taxes /lower spending, the emphasis will be on a loose monetary policy to prevent the economic recovery fading away.

More Budget Analysis at Economics and Politics of the Budget at Economics Help

Home Ownership has been an emotive and important political issue in the UK. Not for nothing do we have the phrase ‘ An Englishman’s home is his castle’.

In the post war period, rising affluence, enabled a marked rise in homeownership as more families could now afford to buy outright rather than rent.

In the 1980s, the Conservative government aggressively promoted the idea of a ‘home owning democracy’ – leading to a further growth in home ownership, helped in particular, by the policy of selling council houses cheaply to tenants.

source: CML – pdf

Home Ownership rates in UK

In 1953, the proportion of owner-occupiers in England was 32 per cent. In 1961 this was 43%

Homeownership rates peaked at just over 70% in 2000. As mentioned in post – ‘first time deposits’, they have now fallen to 68%.

Reasons for Home Ownership

Homeownership is the most popular form of living. The majority of people aspire to be a homeowner, even if they may not be able to afford one. The traditional benefits of homeownership include:

• Benefit from rising Prices and hence rising wealth – historically, house prices have exceeded inflation in UK.
• Potential of Living rent free during retirement years.
• Provides Greater Security, can’t be asked to move.

More: Benefits of buying own house.

However, there are also potential problems of this desire for home ownership.

• The 1980s, which saw a rapid rise in home ownership, also saw a boom and bust in house prices.
• In a bid to get ‘on the property ladder’ many people overstretched themselves getting mortgages several times income.
• Homes can be difficult to sell reducing labour market flexibility.
• Volatility in house prices can leave new buyers with negative equity
• Volatility in interest rates can make mortgage payments unaffordable – e.g. 1991, 1992 period.
• Increased wealth inequality between those who own property and those who don’t

More: Disadvantages of buying house

Homeownership per se is not a bad thing. But, the pursuit of ever increasing homeownership can be a problem when there is a shortage of housing and a volatile housing market. The UK, may well need to learn to lessen its obsession with home ownership.