Is the past a guide to future UK house price falls?

The past is often the only guide we have to the future. But it is not necessarily very helpful as regards the current situation in UK housing. ArabianMoney has previously explained why we see the post-1975 bubble in house prices coming to an end with the recent double top setting the market up for a huge fall (click here).

In a nutshell the argument is that UK house price rises have exceeded inflation since 1975 and have become hugely overvalued on any available measure. That overvaluation now has to correct but to what degree?

90s precedent

The last big house price falls were in the early 1990s, aside from the dip in 2008-9. UK house prices ballooned in the late 80s and spiked higher after the 1987 stock market crash promoted real estate as a no-lose alternative. The correction came from a tightening of interest rates that continued until the UK fell out of the European Exchange Rate Mechanism in late 1992.

House prices corrected from a peak in 1990 and fell 25-40 per cent depending on the area. Before that you have to go back to the early 70s for a meaningful house price correction after the Barber Boom, and there was another in the mid-70s after the oil price hike of late 1973.

But high rates of general inflation in th 70s largely masked the real decline in property values that barely showed up in nominal house prices when smoothed out. However, for individuals buying and selling then there were some nasty experiences of sudden price drops.

Is it any different this time? Well, the international economic circumstances do bare comparison to the early 1970s, except that the deflationary forces at large have more in common with the 1930s and the bust in the global trade cycle and competitive devaluations of that era.

Or the 90s?

By contrast the early 90s look something of a local UK problem with John Major’s poorly conceived monetary policy largely responsible for a deeper recession than the rest of the world. The question this time is whether inflation might suddenly reappear to dull the pain of falling house prices as in the 70s.

Recent sudden rises in the prices of commodities like wheat and cotton do seem to indicate a rebirth of inflation. Oil prices too could easily inflate, particularly if there was a 70s style disruption to supplies from the Middle East. Gold and silver prices certainly indicate inflation, whatever current low bond yields suggest.

However, it seems unlikely that inflation will be high enough to catch up with 35 years of over-valuation of UK homes. The correction in prices will have to be both real and nominal to return the market to a level compatible with long-term stability.

By then house prices will likely be 50 per cent off their peak levels, and most of the banking sector will be forced into public ownership (it is not so far off that already). And the economic pain of that adjustment will be formidable by any standards.

30s then?

The comparison with the 1930s does not stack up very well as house prices were very low as an income multiple, and not overinflated in comparison to everything else. That said it was the extended low interest rates of the 1930s that made is a good decade for the housing market (and for housebuilding).

But can the bond market of today really deliver long-term low interest rates? You only have to look at the amount of money that governments are about to borrow to get an answer to that, as surely investors will want a better return.