EAster traditionally marks the start of the annual home buying season, but this year potential sellers didn’t have to mow the lawn and repaint the living room as the market is already heating up.
Demand for property has been strong since Britain first emerged from lockdown in the summer of 2020. Mortgage approvals have risen to pre-pandemic levels and prices have continued to climb higher.
There are several measures of house price inflation, but they all tell the same thing: annual increases of over 10%. According to figures from Britain’s largest mortgage lender, Halifax, the average UK home rose in price by just over £28,000 last year, which is pretty much in line with what the average UK worker was earning over the same period.
Regular readers of this column will know that I’ve been wondering how long the boom can last, and the answer seems to be taking longer than I expected. Demand for housing continues to outstrip supply even as interest rates start to rise and households face the greatest pressure on their living standards in decades.
The impact on living standards of prices rising faster than wages has hurt consumer confidence and this could weigh on the market in the coming months. Historically, there has been a close correlation between house prices and consumer satisfaction, but as Holger Schmieding, chief economist at Berenberg, pointed out, a large gap has emerged between the two metrics this year.
The mismatch between housing demand and supply in the UK has structural reasons: Britain is a small country with a relatively high population density, severe planning restrictions and a tax system that encourages home ownership.
But it is important to put things in a global context, because this is not a story of British exceptionalism. The past decade has seen a colossal global housing boom that has doubled the value of residential property to $350 trillion (£268 trillion) – four times the annual world production.
Much attention has been paid to stock prices, but as BCA Research’s Dhaval Joshi notes, the size of the US stock market (currently valued at around $45 trillion) is dwarfed by China’s housing market ($100 trillion). The US housing market is worth twice America’s annual GDP; China’s real estate market is worth more than five times China’s GDP.
We’ve been here before. In the early 21st century, money flowed into US subprime mortgages, which became unaffordable when interest rates were raised by the US Federal Reserve. In the run-up to the global financial crisis, the Fed hiked interest rates 17 times by a quarter point and cut borrowing costs from 1% to 5.25%. The housing market collapsed, causing an abrupt change of course.
For more than a decade, the funds to buy houses have been readily available and cheap. Weak growth and low consumer price inflation have allowed central banks to keep official borrowing costs at record lows. During tough times like the global financial crisis and the onset of the coronavirus pandemic, they have pumped money into their economies through the bond-buying process known as quantitative easing.
Now central banks are under pressure as high house price inflation is beginning to be matched by high consumer price inflation. The cost of living has increased by 8.5% in the US and by 7.5% in the euro zone over the past year. The UK government’s preferred measure of the cost of living is expected to rise from 7% to around 9% when the April figure is released next month.
Two recent developments make matters worse: the war in Ukraine and the draconian lockdowns being used in China to combat Covid-19. The first is to keep energy prices high; the second clogs global supply chains and creates bottlenecks.
But rising prices and the ongoing pandemic are affecting both economic activity and inflation. The International Monetary Fund will downgrade its growth forecasts for 2022 and 2023 in its latest World Economic Outlook to be released on Tuesday.
With the prospect of a period of stagflation, there are no good options for central banks. Brutal measures, such as those used in the US in the early 1980s and Britain in the late 1980s, would bring down inflation – but at a cost.
At one point in the boom year of 1988, UK interest rates were 7.5%, but just over a year later they doubled to 15% and then stayed there for another 12 months. The result has been record bankruptcies, record home repossessions and unemployment in excess of 3 million. House prices plummeted and continued to fall in real terms until the mid-1990s.
Since growth is weakening anyway, a different approach is being tried. The plan calls for gradual and modest interest rate hikes in the hope that inflation will return to its target without crashing the economy.
Again, there is no guarantee, and it is worth noting that even a modest rise in US market interest rates since the turn of the year has resulted in a slowdown in demand for mortgages. And this at a time when real (inflation-adjusted) interest rates are significantly negative.
What does it all mean? That means politicians in London, Washington, Frankfurt and (especially) Beijing are rightly nervous. Subprime was the bubble to end all bubbles. Until now.