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Saturday, July 31, 2010

Fortunes diverge for UK house prices and economy

LONDON: After marching to the same tune for the past decade, Britain’s property market and its economy are going separate ways, and further house price falls look likely into 2011 even if the recovery broadens.

In the three months to June, Britain’s economy grew by 1.1%, its biggest quarterly bounce in four years.

Yet UK house prices, which had become a major economic driver in the boom years, fell in every single month of that quarter according to the Halifax index.

Whilst the economy is expected to continue growing, albeit modestly, the outlook for house prices is grim.

Bank of England data on Thursday showed mortgage approvals slipped in June while lending recorded one of its weakest outturns in the series’ history.

Historically, house prices and GDP growth have had a tight correlation because factors such as credit availability, wage growth and consumer confidence have tended to pull in the same direction.

During the credit boom of the Noughties, that correlation was intensified by home owners borrowing and spending against the rising value of their homes.

But things got out of whack in the spring of 2009 when recession prompted the Bank of England to unleash a wave of monetary stimulus and slash interest rates to 0.5%.

The consequence was that mortgage affordability for those already on the property ladder rose to its highest in a generation, allowing prices to rise even though price/earnings ratios - the traditional valuation yardstick - were at uncomfortably high levels.

While property prices and economic growth are likely to synchronise over the longer term, the divergence could persist over the next few years, particularly if interest rates rise.

“My biggest worry for house prices is in the medium term, when the Bank of England raises interest rates,” said Ray Boulger at mortgage broker John Charcol. “The more people get used to low interest rates, the more of a shock it will be.”

House prices in Britain began their rebound in the spring of 2009, when the country was mired in recession, and rose to within 10% of their late 2007 peak earlier this year.

It is likely, however, that low interest rates have just have postponed an inevitable fall to more affordable levels.

Simon Rubinsohn, chief economist at the Royal Institution of Chartered Surveyors, said the ending of the emergency stimulus measures posed a big risk for the property market.

“The stronger the economy, the more likely it is that interest rates will rise and that transitional arrangements after the ending of liquidity support measures won’t be put in place,” he said.

British banks need to refinance almost 800 billion pounds of short term funds by the end of 2012.

This will sap their willingness to lend to homebuyers, particularly when prices are falling and capital buffers need to be rebuilt.

At just over 166,000 pounds, the average price of a home is nearly seven times the average annual UK salary, well above the long term average multiple of 3.7.

Record low interest rates have pushed the cost of servicing mortgage payments to its lowest in 35 years, according to the Council of Mortgage Lenders, but that is little comfort for first-time buyers unable to raise the chunky deposit lenders now require.

Economists, almost all of whom were wrongfooted by the pace of the rebound last year, are growing increasingly bold in forecasting house price falls.

Howard Archer at IHS Global Insight reckons prices will fall 3% to 5% in the second half of this year, with a further drop of 5% to 10% in 2011.

By Reuters

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