The word “deflation” is on everybody’s lips now, with falls in consumer prices the main worry of central bankers and their ilk. But are things really all that bad, and what other type of deflation should we worry about in 2016?
A while ago, I wrote about asset price inflation and how, in order to get a true picture of the effects of the “unorthodox” policies of money printing, asset price increases should be included in the official inflation figures.
They haven’t been, and experts continue to complain about deflation. However, if you look strictly at house prices in London, very rapid inflation has set in, with all its ill effects.
The house price index in London jumped by nearly 50% (47.8% to be precise) to 257.9 in October this year from the 174.5 it hit at its January 2008 pre-crisis peak. By comparison, the consumer price index increased by 21.7% over the same period. UK-wide, house prices have not kept up with consumer prices, advancing by “only” 18.7% since January 2008, to 220.1.
The jump in London house prices was helped by several factors: strong foreign investment (the so-called buy-and-leave type of investor, who usually buy newly built properties and leave them empty), government subsidies for house prices in the form of various help-to-buy programs, strong incentives for buy-to-let buyers, and record low interest rates that have made monthly payments of huge mortgages appear affordable.
There has been no study that I know of (please send a link if you we’ve seen any) about the effect the rapid inflation in house prices has had on demand for other products in the wider economy.
However, generally in an inflationary environment after an initial period when demand increases because people rush to buy before prices go even higher, demand tends to peter out as people’s buying power is eroded by rising prices.
It could be that this is why we’re seeing deflation or at least very low inflation in consumer prices. Psychologically, rapidly rising house prices create a fear for future affordability that may prompt people to hoard cash rather than spend it.
And it’s not just homeowners wanting to move or would-be home buyers who see themselves forced to save more rather than spend, in order to afford ever-increasing prices. Rents are increasing fast as well, cutting into disposable income.
Although initially house price rises were considered good for overall demand because they meant more collateral for those who borrowed against the value of their homes, this is no longer the case.
With the volume of sales collapsing, it’s time home prices came down to more reasonable levels before they hurt the economy even more. One anecdotal example of their ill effect is the fact that there is a shortage of teachers in London and south east as homes are too expensive for teachers to be able to afford them.
The government is starting to realise this and is trying to discourage buy-to-let buyers in the hope that first-time buyers will have more chances to make a purchase – but at these price levels, the amount of debt a first-time buyer would have to take on in London is frightening.
The London house price bubble has been blown to levels never seen before – there have been warnings from two investment banks in recent months about this, but they have not been taken seriously. If it bursts, it could take down the whole economy.
The Bank of England has repeatedly promised that interest rates, if they are to rise at all, would only increase gradually – but does the central bank really control interest rates to that extent?
One big theme for 2016 will be house prices in London – follow them to see where the economy is going.