House prices falling? Don’t bet the bank on it

Housing policy not going to be easy street for the UK government. Lifeofgalileo, CC BY-SA

The news that the British housing market may have reached a turning point, with one forecast showing a price fall in 2015 and a drop in London prices for the first time in three years, will have been welcome news to would-be homeowners. But generation rent will likely be around for some time to come.

While the government says it wants to boost the affordability of homes by building lots more and the Bank of England has taken steps to prevent a price bubble developing, the UK’s economic growth strategy is based on boosting the wealth of the home-owning majority. This means that any fall in house prices, or even a levelling-off before 2018, would be disastrous for the recovery.

Just over 60% of the country’s households are home owners, while the rest rent their homes – many hoping to buy when they can afford to. Because homeowners are still the majority, UK policy has long been tilted towards them, despite higher prices keeping many off the housing “ladder”.

That’s why the coalition has focused on supporting demand for housing (through schemes that co-invest with buyers or publicly subsidise deposits such as Help-to-Buy) – rather than increasing supply. Its own reports suggest that 232,000 new homes are needed per year just to keep pace with demand, but only 109,370 were completed in 2013.

A recovery built on bricks

There’s another reason why UK governments, regardless of party, want house prices to rise. In countries with lower rates of owner-occupation, continued escalation would threaten the recovery. Rising rents, deposits and mortgage payments would leave people less to spend on other things, depressing demand.

But in the UK, rising house prices make a majority feel better-off and enable them to spend more. A key contributor to this is equity withdrawal, where people are able to take out bigger loans, backed by their enlarged housing wealth. A year ago, that was a major driver of the UK’s return to growth.

Maintaining this recovery will, according to the Office of Budget Responsibility (OBR), depend heavily on the continued buoyancy of the housing market. The OBR forecast of steady GDP growth between now and 2018 largely relies on a fall in the household saving rate – to 4.1% of disposable income this year and 3.2% in 2018, from an already-low 5% in 2013.

Equity withdrawal based on solid house-price gains is essential to the rise in household spending that causes this drop in saving. Investment in new housing is another big contributor, its growth rate is forecast to double to 9% this year and climb to 10% in 2015-17.

Neither of these developments is likely if house prices falter. So the OBR’s forecast shows the average house price rising 8.5% this year, 7.8% in 2015, 5% in 2016 and 3.7% thereafter, leaving it 30% higher by 2018/19. This relatively optimistic forecast would be challenged if these growth rates went into reverse, or even levelled off.

Bank struggles for balance

The government will therefore do all it can to avoid a serious fall in house prices before next May’s election – or anytime after it.

That leaves a difficult task ahead for the Bank of England. The present policy of rock-bottom interest rates was designed to stabilise UK banks and revive industrial investment. It only aimed to boost house prices far enough to float the worst-hit owner occupiers out of negative equity. With that task now largely accomplished, the bank wants to stop the house-price revival becoming a bubble. Its deputy governor warns that it would be “dangerous to ignore the momentum” that house prices have acquired in the past year.

Steps taken to rein them in have been relatively mild so far. Not wanting to raise interest rates yet (with inflation below target, at 1.5% in September), the bank has focused on imposing stricter affordability criteria, and limiting the number of high loan-to-value mortgage deals. After the jarring experience of the 2008 crash, the last thing it wants is a “hard landing” in which prices fall again.

But recent experience suggests that, even when it achieves a “soft landing” in which prices level off, central bank action of this kind can have serious social effects. Australia and New Zealand have tried similar measures and found that they tend to deter first-time buyers (who need mortgages). This opens the way for bargain-hunting cash buyers, including real estate investment companies and buy-to-let landlords, who snap up properties which they can then rent out to the households no longer able to buy.

So even a gentle touch on the brakes could make generation rent a lasting reality.

When the IMF cites Britain as having the strongest rich-country recovery this year, it assumes that house prices neither force an interest-rate rise by increasing too quickly, nor puncture household budgets by falling. No wonder George Osborne is looking slimmer – he has a long, roof-high tightrope to walk.