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Consumers' warning

Since the start of 2013, overall consumer spending has risen at barely half the rate of house prices - by just over 11 per cent against a rise in house prices of almost 22 per cent. Thanks to this, the ratio of consumer spending to house prices is now some 10 per cent below its post-1980 average.

This matters because this ratio has been a great predictor of subsequent real GDP growth. Falls in the ratio in the late 70s, late 80s and mid-00s all led to recessions, while the high ratio in the mid-90s led to stronger growth. Since the start of 1981, the correlation between the consumption-house price ratio and subsequent five-yearly real GDP growth has been a 0.64. And since 1990, it has been a hefty 0.88 - which is enormous for a leading indicator.

One reason for this is that high house prices (and hence a low consumption-house price ratio) are themselves a warning sign, because they lead to falling prices and to weaker growth: George Osborne's warning that house prices will fall if we leave the EU omits to add that they might do so even if we don't.

There is, though, another reason. Consumer spending should be forward-looking. When we decide how much to spend, we consider not just our current income but our prospects too, so spending will be stronger the more optimistic we are about our future incomes. Of course, any particular individual might well be wrong about his own future, either because he is irrationally optimistic or pessimistic or because he's gets a genuine surprise. Across millions of people, though, these idiosyncratic irrationalities and surprises should more or less cancel out, with the result that aggregate consumer spending can predict future growth.

In this sense, aggregate spending does what Friedrich Hayek claimed the price system does: it collects the dispersed, fragmentary and partial knowledge of millions of people into meaningful signals. And just as the decentralized price system embodies more knowledge than any central planner can have, so aggregate spending knows more than any centralised forecaster.

All this is why we should worry. A low consumption-house price ratio points to weak growth - of under 2 per cent per year on average over the next five years, if post-1981 relations continue to hold.

What's more, as Martin Lettau and Sydney Ludvigson have shown, and Bank of England economists have corroborated, ratios of spending to wealth also predict equity returns. A below-average ratio of consumption to house prices points to only moderate equity returns - which shouldn't be surprising given that it predicts modest GDP growth.