Something is really wrong with house prices in the UK

By Antonia Oprita

House prices in the UK are getting another boost from the government, just in time for the May 7 general election.

There have been suggestions that the rapid growth in UK property prices, which had almost become a given for many foreign and domestic investors, was cooling down.

Growth in residential property prices in prime central London slowed down to just 3.3% in March in annual terms, the lowest rate in five years.

This is probably due to a combination of the stamp duty tax changes – which tax more expensive property more – and rich foreign investors holding off on new purchases ahead of the election.

Farther out, in various areas of Greater London, prices had been fluctuating and anecdotal evidence showed transactions taking longer to complete.

But they might get a boost soon. A change in pension rules means that pensioners, who are now free to cash in their pension for the first time, might look into putting their pots of money into buy-to-let properties – although that really would not be a good idea.

There are already reports of pensioners queuing up to view properties, while Rightmove, Britain’s biggest online property portal, reported that March was its busiest month ever.

The Guardian says that pension savings are estimated at £12 billion ($18 billion) annually – so there is plenty of money to push up house prices in the UK.

In the short term, this will mean that the housing bubble will continue to inflate as vendors will try to speculate on pensioners’ desire to save into bricks and mortar.

But over the longer term, there is something very wrong with house prices in the UK. The direction of travel is likely to be downwards.

House Prices in the UK Ready for Correction

Analysts at Societe Generale, for instance, say that the RICS house price survey – which is due to be released on Thursday – is likely to point to lower house prices going forward.

House prices in the UK

House prices in the UK are likely to fall rather than rise. Source: Societe Generale

The chart to the left shows that the relationship between a measure of excess demand (new buyer enquiries according to RICS minus new vendor instructions) and the RICS price index lags by 10 months.

“This strongly points to a further fall in the price index in the coming months,” Brian Hilliard, an analyst with Societe Generale, said.

The bubble will not deflate without a fight, of course. The Bank of England is likely to do its bit to ensure that house prices in the UK stay at elevated levels, as it has done over the years since the financial crisis.

The chief economist of the Bank of England, Andrew Haldane, even said the next move in interest rates is likely to be down, rather than up, invoking the threat of deflation.

However, one problem is that central banks around the world do not count asset price inflation in their measure of inflation, thus ignoring bubbles such as the one in house prices in the UK.

Besides the new freedoms for pensioners to take their pot out and buy property and a Bank of England keen to keep interest rates at a historical record low, the government has thrown all kinds of other subsidies at the property market.

Help to Buy (in its various forms) as well as subsidising landlords via housing benefit – and thus making sure rents stay at elevated levels, too – as well as various restrictions that make it very difficult for new property to be built all converge to ensure house prices in the UK stay high.

Subsidies for Property Prices Become a Problem

The problem is how long can this go on. The UK economy has indeed created many jobs and has been growing faster than the beleaguered eurozone. But a lot of the jobs have been low-paying service sector positions and in fact a drain on the taxpayer.

The average rent in London is £1160 per month – this would normally price out the army of fast food workers, cleaners, care workers and others on salaries barely adding up to £12,000 a year, unless they could rely on benefits to be able to keep a roof over their head.

Even nurses and teachers struggle to pay London rents from their salaries, and moving further out is only partly a solution because of the high cost of public transport.

Some young teachers on low salaries are forced to share accommodation, sometimes even two to a room, in London, while others travel for three or four hours a day from home to work because they cannot afford to move closer, according to a teachers’ union.

But the government will not be able to keep up the subsidies forever. Already, Britain is facing a problem more familiar to developing countries: that of twin – budget and external — deficits.

The budget deficit has fallen to around 4% of gross domestic product last year from 5.8% in 2013 — but it still breaches what the European Union considers a prudent 3% of GDP.

The current account deficit is “one of the more significant risks to the UK’s growth outlook,” according to a recent research note by Capital Economics’ Paul Hollingsworth. The external gap was around 5.5% of GDP last year, the largest in peacetime history.

The pensioners moving their savings into buy-to-let property, as well as others who think that taking out a mortgage to speculate on the continuous rise in house prices in the UK is a good idea, should read Hollingsworth’s words of warning:

“It is easy to imagine a situation in which investors become unwilling to hold UK assets, sterling falls sharply and imported inflation picks up quickly.

The MPC would then have a choice, either to do nothing (and one could argue that a lower pound and some more inflation is just what the economy needs!) or hike interest rates aggressively, which risks choking off the recovery.”

Buyers of property in the UK and especially in London, unless they are rich oligarchs, are heavily indebted, because the government has encouraged this trend.

If interest rates do end up increasing, the bubble will burst taking everyone with it – including buy-to-let investors who have relied on big mortgages and ever-increasing house prices in the UK.

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