Saturday, November 27, 2004

Economic Outlook: David Smith: Wobbly house prices cast a long shadow (UK)

The Times

THE DAYS are getting shorter and the house-price forecasts are dropping faster than the last of the autumn leaves. Forecasts of a price crash, which began life as a minority view, are now bang in the middle of the mainstream.

Capital Economics, which got there first, had its 20% price fall starting this year with a 5% drop and continuing for another couple of years. It will be wrong on timing — prices will end this year at least 10% higher than at the start — but it will argue “better late than never”.

Barclays’ chief economist Christopher Smallwood, my predecessor in this job, predicts a 20% fall from present levels. Deutsche Bank, which had been predicting house-price stagnation, has joined the mild-crash school. It now expects prices to drop 10%-15% as a prelude to stagnation. ABN Amro has prices falling 10% next year.

Housing is the story of the moment, and not just at dinner parties. It has hit the financial markets in at least three ways. The housing downturn has changed perceptions about the interest-rate outlook.

One of the most aggressive interest-rate forecasts is from John O’Sullivan at Dresdner Kleinwort Wasserstein. He expects the Bank of England to cut the base rate to 4% by the end of next year in an efforts to limit the house-price drop to 5%.

My view is that the Bank’s monetary policy committee, having worked hard to get rates up from last year’s emergency low level of 3.5% to the present 4.75%, won’t surrender cuts without a fight and would like to keep rates where they are for quite a long time. But these things can change rapidly.

The shift in rate expectations, particularly among City economists, has been dramatic, and it is reflected in the currency markets. The pound has been climbing against the dollar but slipping against the euro. Its rise against the sickly dollar would have been much bigger had it not coincided with the softening of the outlook for rates.

The other impact of housing will be on firms, particularly retailers. The Bank has been working hard to try to prove that housing and consumer spending have “decoupled”, because the final two years of the boom in house prices coincided with a softening of spending growth. But Mervyn King, the governor, is too good an economist to have real confidence in a view based on a short run of data. When the housing market tanked in the past, consumer spending suffered. In the absence of better evidence to the contrary, that has to be the assumption this time.

Charlie Bean, the Bank’s chief economist, repeated the “decoupling” case last week, but admitted there were big uncertainties.

Perhaps the most interesting impact of the new housing climate will be on Gordon Brown, who this weekend is putting the finishing touches on Thursday’s pre-budget report.

Booming house prices were as welcome at the Treasury as flower arrangements at a hay-fever convention. The Treasury could not understand how, having delivered low- inflation economic stability, it had a housing boom as powerful as in the unstable days of the late 1980s. Hence the reviews it commissioned by Kate Barker on housing supply and David Miles on mortgages.

And underlying this quest for understanding has been the fear, certainly for the chancellor and his political advisers, that boom could turn to bust. For a government that promised no return to boom and bust, the excuse that only one part of the economy had turned to bust would cut little ice with voters.

Oliver Letwin, the shadow chancellor, while stressing that he neither wishes for nor expects a housing crash, puts it well. For a while after Brown’s £5 billion annual raid on pension funds, the effect was disguised by a rising stock market but then exposed when share prices fell. For the past few years Labour’s general tax rises have been disguised by the wealth effects of rising house prices. As that stops, people will become more aware of the tax squeeze, and the expectation of hikes to come. The feelgood factor will not be what it was.

The relationship between house prices and election outcomes is not a perfect one. Having slipped in 2000, prices were rising strongly at the time of the 2001 election, which Labour won comfortably. On the other hand, the Tories lost the 1997 election despite a strong housing market, having won in 1992 at a time when prices were falling. Margaret Thatcher’s 1983 and 1987 victories came when prices were soaring.

The change in the housing climate will be a test in another way. In the budget the Treasury factored in a modest slowdown in consumer spending next year, from just over 3% to 2.5%, but within the context of strong overall growth of 3% to 3.5%, with exports and investment taking up the slack.

With the CBI warning last week of the effect on business of high oil prices, as well as the potential damage to world growth of a plunging dollar, official expectations of a “rebalancing” away from consumers in the context of a robust overall economy seem to be optimistic.

That is not just an immediate concern. Even if the prospect is of a long period of stagnation for house prices rather than a crash (my view), something fundamental will have changed. House prices have trebled in the past nine years. We are about to find out how important that was as an engine of economic growth.

Finally, just to put things in perspective, the ratio of house prices to average earnings — the normal valuation measure — is now 5.7, compared with a long-run average of just under 4. I can tell you, courtesy of Davy Stockbrokers in Dublin, that the comparable ratio in Ireland averaged 3.5 in the period 1985-95 and now stands at 8.1. After looking over the edge in the wake of the September 11 attacks on America, Irish house prices are rising 12%-13% a year and show little sign of slackening. Interesting.

PS: Last week’s reference to the skip index, my economic indicator based on the number of skips in the street, brought some excellent suggestions. The most popular related to lorries. It appears I should be looking at the number of heavy lorries on the road, particularly those travelling in the early hours when most of us are tucked up in bed. Tim Denison of retail specialists SPSL suggests another: the time it takes to get through on the phone to your credit-card company.

To embark on a slightly different strand, I was invited the other day to an evening of “drinks and networking”. Drinks, yes, but networking fills me with the kind of horror expressed by the late Sir Nicholas Ridley when asked, on quitting the cabinet, whether he intended to spend more time with his family. That, he said, was the last thing he would want to do.

This kind of jargon is taking over the world. On the radio, I really did hear somebody say, “we’re a people business”. On the television news somebody was talking without embarrassment about being “on alert 24/7”. If I hear another consultant type say: “You can talk the talk but can you walk the walk?” I will gladly strangle him. As I will, the next time I hear: “Do the math.”

What does it mean when somebody offers to give you the “heads up” on something? Or, my particular bête noire, a Home Counties accent, usually female, saying those two little words beloved of Australian soaps: “No worries.”

If somebody can write a bestseller on the use of the apostrophe, there may be one here. In the meantime, there’s a copy of my own Free Lunch for the best example of irritating business, economic or other jargon. The terms used in this column every week are admissible.


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