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OPINION

Safer than cash

Safer than cash
January 21, 2016
Safer than cash

I say so for a simple reason: there's a strong correlation between house prices and sterling's trade-weighted index - of 0.5 for annual changes since 1991. More importantly, every significant fall in house prices since then has been accompanied by a fall in sterling: in 1992-93, 1995, 2008-09 and 2011. This suggests that foreign currency is a hedge against house prices: it should rise if they fall.

Anyone who is long of housing and worried about a possible house price fall - such as people who are approaching retirement and hoping to trade down to release housing equity - should therefore think of foreign currency as an especially safe asset. It is, in effect, insurance against a fall in house prices. And given that houses are so expensive, such a fall at some time should not be ruled out.

Of course, all insurance comes at a price. The correlation suggests that foreign currency will lose you money if house prices continue to rise. But a loss you incur in good times might be a price worth paying in exchange for profits in bad times.

Annual changes in house prices and sterling

This strong correlation between house prices and sterling is surprising. You'd expect the same low interest rates that raise house prices to also weaken sterling, causing a negative correlation between the two. However, we've not seen this except for a few years in the early 2000s. And some economists contend that housing is not net aggregate wealth. If they're right, that rules out one obvious source of positive correlation that rising wealth should increase demand for money and hence the price of sterling.

Which poses the question: why, then, is there such a positive correlation?

One reason lies in sentiment or expectations (the difference between these is a matter of ideology). Pessimism about the UK economy would tend to depress both sterling and house prices.

A second reason is that the same global recession or financial crisis that depresses house prices also causes a general global 'flight to quality', which leads investors to dump sterling in favour of safer assets. For this reason, history suggests that it doesn't matter much which major currency one uses as a house price hedge. Correlations between house prices and the US dollar, Japanese yen or Swiss franc are much the same, although that between house prices and the euro is a little lower.

These two reasons are sufficiently strong as to suggest that the correlation between sterling and house prices might remain positive when house prices fall again. This could be good news for those people who are worried by the possibility of a fall in house prices, as it means that there is an asset which is safer than sterling cash.