Can the UK inflate fast enough to support house prices?
Posted on 13 August 2010 with 2 comments from readers
Devaluing the pound earlier this year was a good start but the UK is going to have to seriously inflate general price levels if the economy is going to avoid the agony of falling house prices with their impact on consumer spending, bank balance sheets and the illusion of wealth.
This is broadly speaking what happened in the 1970s. House prices fell after the Oil Shock of 1973 and then came the inflation of 1975-80. This brought nominal house prices back up to pre-crisis levels by the end of the decade but by then general price levels had doubled.
50% real fall in house prices
In real terms house prices fell by half from their peak in the early part of the 70s but the impact was disguised in nominal terms by inflation. That also helped to get the national economy back on its feet, although it was a bumpy ride in the late 70s and few businesses did well.
Only a stern dose of deflation from Mrs Thatcher’s government post-1979 and a very nasty long recession and high unemployment brought a recovery that lasted until Mr Brown decided to spend this inheritance to become Prime Minister. So where are we now?
History never quite repeats itself. The new coalition government seems pretty Thatcherite with its commitment to massive cuts and higher taxes. That said support for the pound looks pretty weak, although financial markets generally like governments that wear hair shirts.
Back to the 70s?
The Callaghan Government of the late 70s – actually supported by the Liberals in a parliamentary pact for its last 18 months in a precursor of today’s coalition – pursued an agenda rather like Mr Brown had in mind with less aggressive cutbacks than Mrs Thatcher pushed through. That helped stop house prices falling and turned them around in nominal terms.
Therefore it looks as though the new government is going to depress house prices further to the downside than might have happened under another Brown administration. Austerity for the general economy, with higher unemployment and people worried about losing their jobs, can hardly be supportive of house prices.
If you think historically, what would have happened in the late 1970s if Mrs Thatcher had been in charge then? The recession of the Oil Shock would have been longer and deeper, and the recovery presumably quicker when it came. But UK house prices would have dropped further in nominal value than actually happened.
So the conclusion has to be that the new government is about to preside over a massive fall in UK house prices. Can it hold true to this course with the public outrage that will follow? We will see.
2 Comments posted by readers:
The housing market is being supported by very low interest rates – and will continue to be supported for the next 2-5 years. Those in work are using this opportunity to pay off debt. They will sit tight. Although unemployment has risen and may continue to do so, repossessions are falling because with such low rates, it is easier for households to meet the payment by switching to interest only – they are not forced to sell. House prices may decline in real terms over the next 5 years, but a massive fall in prices looks unlikely to me.
It is clear that the Bank of England will keep repeating the mantra that deflation is the order of the day and continue to keep interest rates low which under a free market would be some way above the present 0.5% thereby resulting in significant falls in house prises. The present prop up job has been a tremendous success with London prices returning to 2007 peak and above values. What remains to be seen is the ratio of falls in both nominal and real terms. The threat of public sector cuts will have little impact on the London market. Instead we will see a significant North/South divide with heavy falls in the later.
With a 75% fall in property values since 2007 if measured against gold then further falls can be expected as inflation grows and sterling loses value further value.