The housing market is often a good indicator of the level of confidence in an economy. Prior to the credit crunch, there had been a house price bubble and as the financial crisis began and economies plunged into recession, house prices began to fall significantly. In the last few months, the housing market has begun its recovery and data from the ONS shows average property prices up by 5.4% across the UK in November, compared with a year earlier.
When we analyse the housing market, or any market, we have to give attention to both demand-side and supply-side factors. It is the combination of these factors that yields the equilibrium price. For most people, buying a house will represent their single biggest expenditure and so there are many factors that need to be considered.
The demand for housing is affected by incomes, by the availability of mortgages, the rate of interest and hence the cost of mortgages. Speculation also tends to be a key factor that influences the demand for houses, as people may buy houses if they believe that prices will soon rise. Of course, simply by responding to expectations about future price changes causes the price changes to happen – a classic case of self-fulfilling speculation.
The availability of mortgages has been one of the biggest factors increasing the demand for and hence price of houses in recent months. More individuals have been able to get onto the property ladder and, with confidence returning to the market, these factors have caused a rightward shift in the demand for owner-occupied houses.
Another key factor has been the growth in the demand for housing as an investment opportunity, in particular from the global super rich. This has been of particular concern in London, where there are fears of a housing bubble developing and of lower-income households being priced out of the market.
At the same time, there has been a growth in the supply or housing and thus a rightward shift of the supply curve. Ceteris paribus, this would push down average prices. However, the data suggest that house prices, especially in London, have increased, implying that the impact on price of the increase in demand has more than offset the downward force in prices from the increase in supply. Part of this can be explained by the demand-side factor of an increase in demand for top-end properties, which ‘has been distracting developers from the need for more affordable accommodation.’ When asked about the changes observed in the London housing market, Civitas said:
London is one of the most – if not the most – attractive property markets for international investors all over the world. It is also at the centre of an affordability crisis in the UK which is having serious consequences for younger people and the less well-off…For too many it [investment at the top end of the market] is providing financial shelter rather than human shelter.
With the upward pressure on house prices, many are now warning of another bubble developing in London. When comparing house prices in London with a Londoner’s income, Ernst and Young found that house prices were 11 times average annual income. Data like this were last seen prior to the financial crisis and it is this which has led to concerns of a post-crisis bubble.
There are suggestions that more action is needed to combat this bubble, such as imposing a limit in income multiples in relation to how much of a mortgage you are able to borrow. Another criticism levelled at the market is the government’s Help to Buy scheme, which critics argue is raising demand and pushing up prices, because there is no matched increase in supply.
So, with the rest of the market returning to some semblance of normality, it is currently just London showing signs of a bubble and we are all well aware of what the consequences might be if a bubble is allowed to grow and then eventually burst. The following articles consider the housing market.
Housing bubble forming in London, warns Ernst and Young BBC News (3/2/14)
London housing market shows new bubble sign – report Reuters, Andrew Winning (3/2/14)
Expert calls for stronger action to tame London housing bubble risks Independent (21/5/12)
London shows signs of house price ‘bubble’, experts warn The Telegraph, Scott Campbell (3/2/14)
Economic forecasters call for measures to cool down London’s property market The Guardian, Rupert Neate (3/2/14)
Think-tank calls for a ban on rich foreigners buying homes in London to puncture property bubble Mail Online, Lizzie Edmonds (2/2/14)
London property bubble to last until 2018 Sky News (3/2/14)
Questions
- What are the key factors that will affect (a) the demand for and (b) the supply of housing?
- Which factors explain why house prices in London have increased relative to prices across the country? Identify which factors are demand-side and which are supply-side.
- How has Help to Buy affected the housing market?
- What government policies could be implemented to ‘puncture’ the bubble?
- Why is a housing bubble a problem?
- Why has a house price bubble not emerged in the rest of the UK?
Interest rates in the UK have been at 0.5% since mid-2009, when they were reduced with the objective of stimulating the economy, through encouraging consumption and investment. Over the past 12 months, economic recovery has begun and with the housing market rising by 8.4% over the past year, what can we expect from interest rates?
Interest rates are a powerful tool of monetary policy and affect many of the components of aggregate demand. As such, they are also a key tool in achieving low and stable inflation rates and keeping unemployment low. Unemployment has been falling, as the economic recovery has taken hold, but is still above the 7% level that the Bank of England has said is needed before rates are increased. However, with the improvements in the housing market,
some are now expecting interest rates to go up sooner than previously thought. (Click here for a PowerPoint of the chart.)
28 economists were questioned about the future of interest rates in the UK and 93% of those asked were of the opinion that interest rates will still be at 0.5% by the end of 2014. Furthermore, more than 50% think that interest rates will not begin to go up until the second half of 2015 and 15% suggest that they will not increase until 2016.
What happens to interest rates will depend on many things, including changes in productivity, unemployment trends, wage growth and inflation. It is also likely to depend on economic changes in countries around the world. The following articles consider the future of interest rates.
UK interest rates to stay at 0.5% in 2014 – economists BBC News (3/1/14)
It is high time we raised interest rates and returned to normality The Telegraph, Jeremy Warner (2/1/14)
BoE will ‘move goalposts’ on interest rates Financial Times, Chris Giles and Claire Jones (1/1/14)
Interest rate rise with no wage increase ‘will push heavily-indebted to edge’ The Guardian, Heather Stewart (2/12/14)
BoE may lower jobless rate guidance, but not this month – Reuters poll Reuters, Suzanne Plunkett (3/1/14)
Questions
- Explain how each component of aggregate demand will be affected by changes in interest rates.
- How do interest rates affect unemployment?
- Interest rates are used to keep inflation on target. Explain how this is done.
- What might be the effect on the macroeconomic objectives if interest rates are increased?
- What are the arguments (a) for increasing Bank rate and (b) for maintaining it at the current 0.5% level?
As the old year gives way to the new, papers have been full of economic forecasts for the coming year. This year is no exception. The authors of the articles below give their predictions of what is to come for the global economy and, for the most part, their forecasts are relatively optimistic – but not entirely so. Despite a sunny outlook, there are various dark clouds on the horizon.
Most forecasters predict a higher rate of global economic growth in 2014 than in 2013 – and higher still in 2015. The IMF, in its October forecasts, predicted global growth of 3.6% in 2014 (up from 2.9% in 2013) and 4.0% in 2015.
Some countries will do much better than others, however. The USA, the UK, Germany and certain developing countries are forecast to grow more strongly. The eurozone as a whole, however, is likely to see little in the way of growth, as countries such as Greece, Spain, Portugal and Italy continue with austerity policies in an attempt to reduce their debt. 
Chinese growth has slowed, as the government seeks to rebalance the economy away from exports and investment in manufacturing towards consumption, and services in particular. It is still forecast to be 7.3% in 2014, however – well above the global average. Japanese growth has picked up in response to the three arrows of fiscal, monetary and supply-side policy. But this could well fade somewhat as the stimulus slows. The table shows IMF growth forecasts for selected countries and groups of countries to 2018.
Much will depend on what happens to monetary policy around the world. How quickly will monetary stimulus taper in the USA and in Japan? Will the ECB introduce more aggressively expansionary monetary policy? When will the Bank of England start raising interest rates?
Growth within countries is generally favouring those on higher incomes, with the gap between rich and poor set to continue widening over the coming years. The pay of top earners has continued to rise considerably faster than prices, while increasingly flexible labour markets and squeezed welfare budgets have seen a fall in living standards of many on low incomes. According to a Which? survey (reported in the Independent article below), in the UK:
Only three in ten expect their family’s situation to improve in the new year, while 60% said they are already dreading the arrival of their winter energy bill. The Which? survey also found that 13 million people could afford to pay for Christmas only by borrowing, with more than four in ten using credit cards, loans or overdrafts to fund their festive spending. A third of people (34%) also dipped into their savings, taking an average of £450 from their accounts.
If recovery is based on borrowing, with real incomes falling, or rising only very slowly, household debt levels are likely to increase. This has been stoked in the UK by the ‘Help to Buy‘ scheme, which has encouraged people to take on more debt and has fuelled the current house price boom. This could prove damaging in the long term, as any decline in confidence could lead to a fall in consumer expenditure once more as people seek to reduce their debts.
And what of the global banking system? Is it now sufficiently robust to weather a new crisis. Is borrowing growing too rapidly? Is bank lending becoming more reckless again? Are banks still too big to fail? Is China’s banking system sufficiently robust? These are questions considered in the articles below and, in particular, in the New York Times article by Gordon Brown, the former Prime Minister and Chancellor of the Exchequer.
Articles
Global economy: hopes and fears for 2014The Observer, Heather Stewart and Larry Elliott (29/12/13)
Looking ahead to 2014 BBC News, Linda Yueh (20/12/13)
Low hopes for a happy new financial year in 2014 Independent, Paul Gallagher (29/12/13)
Brisk UK economic growth seen in 2014 fuelled by spending – Reuters poll Reuters, Andy Bruce (12/12/13)
GLobal Economy: 2014 promises faster growth, but no leap forward Reuters, Andy Bruce (29/12/13)
My 2014 Economic Briefing Huffington Post, Tony Dolphin (27/12/13)
Three UK Economy Stories that will Dominate in 2014 International Business Times, Shane Croucher (27/12/13)
Who You Calling a BRIC? Bloomberg, Jim O’Neill (12/11/13)
Hope and Hurdles in 2014 Project Syndicate, Pingfan Hong (27/12/13)
On top of the world again The Economist (18/11/13)
Digging deeper The Economist (31/10/13)
BCC Economic Forecast: growth is gathering momentum, but recovery is not secure British Chambers of Commerce (12/13)
Eight predictions for 2014 Market Watch, David Marsh (30/12/13)
Stumbling Toward the Next Crash New York Times, Gordon Brown (18/12/13)
Central banks must show leadership to rejuvenate global economy The Guardian, Larry Elliott (1/1/14)
Global economy set to grow faster in 2014, with less risk of sudden shocks The Guardian, Nouriel Roubini (31/12/13)
A dismal new year for the global economy The Guardian, Joseph Stiglitz (8/1/14)
Forecasts and reports
World Economic Outlook (WEO) IMF (October 2013)
Economic Outlook OECD (November 2013)
Output, prices and jobs The Economist
Bank of England Inflation Report: Overview Bank of England (November 2013)
Questions
- What reasons are there to be cheerful about the global economic prospects for 2014 and 2015?
- Who will gain the most from economic growth in the UK and why?
- Why is the eurozone likely to grow so slowly, if at all?
- Are we stumbling towards another banking crisis, and if so, which can be done about it?
- Why has unemployment fallen in the UK despite falling living standards for most people?
- What is meant by ‘hysteresis’ in the context of unemployment? Is there a problem of hysteresis at the current time and, if so, what can be done about it?
- Explain whether the MINT economies are likely to be a major source of global economic growth in the coming year?
- Why is it so difficult to forecast the rate of economic growth over the next 12 months, let alone over a longer time period?
UK house prices are incredibly volatile. This helps to explain the fascination that many of us have with the British housing market. According to the latest ONS house Price Index, the average UK house price in August 2013 was 3.8 per cent higher than 12 months earlier. The rates varied across the home nations: 4.1 per cent in England, 1.1 per cent in Northern Ireland, 1 per cent in Wales and -0.7 per cent in Scotland. Here we take a look at international house price inflation rates. Is the British housing market as unique as we think it is?
Let’s begin at home (excuse the pun). If we take the period from 1970 Q1 to 2013 Q2, the average annual rate of house price inflation across the UK is 9.7 per cent. The average rate in England is 9.8 per cent, as it is in Wales too, while in Scotland it is 9.0 per cent and in Northern Ireland it is 8.8 per cent. While the long-term averages of the UK nations are rather more similar than perhaps we might expect, what is quite interesting is the differences that emerge in more recent times. If we take the period from July 2008 to August 2013, the average annual rate of house price inflation in the UK is -0.2 per cent, in England it is 0.1 per cent, in both Wales and Scotland it is -1.0 per cent, while in Northern Ireland it is -11 per cent.
The recent English average is heavily distorted by London and to a lesser extent the rest of the South East. In London and the South East the average annual house price inflation rates since July 2008 have been 2.6 per cent and 0.2 per cent respectively. In all the other English regions the average rate has been negative. In my own region of the East Midlands the average rate has been -1.2 per cent – this is exactly the UK average if both London and the South East are removed from the figures.
Now let’s go international. Chart 1 shows annual house price inflation rates for the UK and six other countries since 1997. Interestingly, it shows that house price volatility is a common feature of housing markets. It is not a uniquely British thing. It also shows that the USA is notable for its relatively robust house price inflation rates of late. In the first half of 2013 annual house price inflation has been running at 7 per cent in America, compared with 2 to 3 per cent here in the UK. In contrast, the Netherlands has seen near-double digit rates of house price deflation over the past year, albeit with a rebound in the third quarter of this year. (Click here to download a PowerPoint of the chart.)
The chart captures very nicely the effect of the financial crisis and subsequent economic downturn on global house prices. Ireland saw annual rates of house price deflation touch 23 per cent in 2009 compared with rates of deflation of 12 per cent in the UK. Denmark too suffered significant house price deflation with prices falling at an annual rate of 15 per cent in 2009.
House price volatility appears to be an inherent characteristic of housing markets worldwide. Let’s now consider the extent to which house prices rise over the longer term. In doing so, we consider real house price growth after having stripped out the effect of consumer price inflation. Real house price growth measures the growth of house prices relative to consumer prices.
Chart 2 shows real house prices since 1996 Q1. (Click here to download a PowerPoint of the chart.) It shows that up to 2013 Q2, real house prices in the UK have risen by a factor of 2.24, i.e. they are two and a quarter times higher. This is a little less than in Sweden where prices are 2.5 times higher.
Chart 2 shows that the increase in real house prices in the UK and Sweden is significantly higher than in the other countries in the sample. In particular, in the USA real house prices in 2013 Q2 are only 1.16 times higher than in 1996 Q1. In the US actual house prices, when viewed over the past 17 years or so, have grown only a little more quickly than consumer prices.
The latest data on house prices suggest that house price volatility is not unique to the UK. However the rate of growth over the longer term relative to consumer prices is markedly quicker than in many other countries. It is this which helps to explain the amount of attention paid to the UK housing market – and not least by policy-makers.
Data
House Price Indices: Data Tables Office for National Statistics
Articles
First time buyers in race to beat house price rises Telegraph, Nicole Blackmore (8/11/13)
House prices soar by £13,000: Values rise at fastest rate for 3 years Express, Sarah O’Grady (7/11/13)
House prices: ‘south-east set to outpace London’ for first time in a decade Guardian, Jennifer Rankin (6/11/13)
UK house prices hit record level, says ONS BBC News, (15/10/13)
UK house prices rise at fastest pace in three years in October – Nationwide Reuter (31/11/13)
Jonathan Portes: UK house prices a ‘force of evil’ BBC News, (5/11/13)
Questions
- What is meant by the annual rate of house price inflation? What about the annual rate of house price deflation?
- What factors are likely to affect housing demand?
- What factors are likely to affect housing supply?
- Explain the difference between nominal and real house prices. What does a real increase in house prices mean?
- How might we explain the recent differences between house price inflation rates in London and the South East relative to the rest of the UK?
- What might explain the very different long-term growth rates in real house prices in the USA and the UK?
- Why were house prices so affected by the financial crisis?
- What factors help explain the volatility in house prices?
The strength of the housing market is often a key indicator of the strength of the economy. But, the opposite is also true: a weak economy often filters through to create a weak housing market. With the current weak economy, a boost in confidence is needed and signs suggest that the housing market is beginning to recover.
While the picture of the housing market today is nothing like the pre-crisis view, things are beginning to look up. For a couple of years now, house price inflation in the UK has been very close, if not equal to zero. However, data from Nationwide Building Society suggests that in May, house prices rose by 0.4% and the once stagnant year-on-year change in house prices rose to 1.1% (see chart below: click here for a PowerPoint of the chart). This is the fastest it has grown since the end of 2011.
Commentators have suggested that this latest data is an indication that ‘the market is gaining momentum’. A further confirmation of this rejuvenated market came with the data that property sales were 5% up each month this year, than the average monthly level for 2012. Despite this improvement, they still remain well below the pre-crisis levels.
Which factors have contributed to this tentative recovery? Most households require a mortgage to purchase a house and, given the central role that the housing market played in the financial crisis with companies engaging in excessive lending as a means of expanding their mortgage books, the availability of mortgages fell. The number of mortgage approvals is likely to feed through to affect the number of house sales and these have improved in the first few months of 2013. Interest rates offered by lenders have also fallen, making mortgages more affordable, thus boosting demand. Furthermore, government assistance is available to help individuals put a deposit down on a house, by offering them an equity loan. Further measures are due to come into effect in January 2014, with the aim of providing a further boost to the housing market. The chief economist at Nationwide, Robert Gardner said:
Widespread expectations that the economy will continue to recover gradually in the quarters ahead, that interest rates will remain low, and the ongoing impact of policy measures aimed at supporting the availability and lowering the cost of credit all provide reasons for optimism that activity will continue to gain momentum in the quarters ahead.
Despite the optimism, the situation is different across the UK, with some areas benefiting more than others. London and the South-East are driving this 0.4% rise, whereas other areas may be in need of further assistance to keep pace (see The UK housing market: good in parts).
Although these latest data may be a sign of things to come, it is also possible that things could go the opposite way. Incomes remain low; employment data are hardly encouraging; and the spectre of inflation is always there. Perhaps most importantly, consumer confidence remains fragile and until that gains momentum, uncertainty will continue to plague the UK marketplace. The following articles consider this issue.
Articles
UK house prices again up in May, says Nationwide The Guardian, Hilary Osborne (30/5/13)
Housing market could boost retail industry, Kingfisher says The Telegraph, Graham Ruddick (30/5/13)
UK house prices see modest rise, says Nationwide BBC News (30/5/13)
Hugh’s Review: House prices in spotlight BBC News, Hugh Pym with Yolande Barnes of Savills and Matthew Pointon of Capital Economics (31/5/13)
House prices are racing ahead as stimulus for the market kicks in Independent, Russell Lynch (31/5/13)
’Pick up’ in house prices recorded in sign of market confidence, says Nationwide Independent, Vicky Shaw (30/5/13)
House prices at highest level for nearly two years as confidence in UK economy grows and mortgages get cheaper This is Money, Matt West (30/5/13)
Stamp duty is ‘choking’ housing market as it rises seven times faster than inflation over last 15 years Mail Online, Tara Brady (28/5/13)
Nationwide launches Help to Buy mortgages The Telegraph, William Clarke (29/5/13)
UK home prices rise most in 18 months, Nationwide says Bloomberg, Jennifer Ryan (30/5/13)
House price data
Links to house price data The Economics Network
Statistical data set – Property transactions Department of Communities and Local Government
Nationwide house price index Nationwide Building Society
Halifax House Price Index Lloyds Banking Group
Lending to individuals – November 2012 Bank of England
Questions
- How is the equilibrium determined in the housing market? Using a demand and supply diagram, illustrate the equilibrium. Make sure you think about the shapes of the curves you’re drawing.
- Which factors affect the demand for and supply of housing?
- Why are there regional variations in house prices?
- Why is the housing market a good indicator of the strength of the economy?
- Why have house prices risen throughout 2013? Is the trend likely to continue?
- If the housing market does indeed gain momentum, how might this affect the rest of the economy? Which sectors in particular are likely to benefit?
- Explain why the government’s intervention in the housing market could be seen to have a multiplier effect?
- Concerns have been raised that the government’s schemes to help the housing market may create a house price bubble. Why might this be the case?
The housing market is often a good indicator of the level of confidence in an economy. Prior to the credit crunch, there had been a house price bubble and as the financial crisis began and economies plunged into recession, house prices began to fall significantly. In the last few months, the housing market has begun its recovery and data from the ONS shows average property prices up by 5.4% across the UK in November, compared with a year earlier.
