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Consumers' house price warning

It's not just economists who expect house price inflation to fall: so too does the wisdom of crowds.
Consumers' house price warning
  • Retail sales have recently been a good predictor of house prices – and they are now warning that these will stagnate.
  • This prediction could be wrong – but unless there is government intervention it will because something unusual happens. 

The boom in house prices cannot last, economists believe. According to a recent survey by the Treasury, they expect that house price inflation – which is currently 11 per cent on the Halifax’s measure and 14.3 per cent on the Nationwide’s – will drop to below 5 per cent at the end of this year and to around 2 per cent at the end of 2023.

It’s not just economists who expect this, however. So too, implicitly, do ordinary people. My chart shows the point. It shows that the ratio of retail sales to house prices has in recent years predicted house price moves. When retail spending was low relative to house prices in 2007 and 2016 house prices subsequently fell or stagnated. And when retail sales were high in 2003 and 2012 house prices subsequently rose a lot.

With this ratio now close to its lowest since 2008, it points to only weak house price growth over the next three years.

One reason for this relationship is simply that consumer spending is partly forward-looking: we spend more today if we anticipate good times than if we anticipate bad. Low spending is therefore a sign that households in aggregate are bracing themselves for hard times – falling real wages or rising unemployment – which are circumstances in which house prices do badly. And because there is often wisdom in crowds, households’ expectations are often correct on average.

But there’s another reason for it. House prices like share prices, are prone to momentum with the result that they eventually overreact on the upside and downside, becoming too cheap or too expensive. Comparing prices with any stable(ish) upward-trending data will tell us what is “too cheap” or “too expensive”. Retail sales do this job.

But something else also does the job – equity prices. When house prices have been low relative to equities (such as in 2000) they have subsequently done well. And when they have been high (such as in 2007) they have gone on to fall. This is true whether we look at moves in house prices in themselves or moves in them relative to equities.

This ratio is now sending much the same message as the ratio of retail sales to house prices and indeed economists’ forecasts – that prices will not rise much in the next three years. This is not to say that the market will crash – the ratios point to only around a one-in-four chance of prices being lower in 2025 than they are now – but the indicators point to house prices not rising much at all in real terms.

We have, therefore, a rare consensus. Whenever there is a consensus, however, we must question it. Hence the question: why might these forecasts, implicit and explicit, be wrong?

In the near term, it’s easy to see why. Just as over-priced equities can become even more over-priced, so too can houses. What’s more, house prices are quicker to adjust upwards than downwards, because sellers are slow to cut asking prices. When there is a change in relative demand therefore – such as increased demand for rural properties and less demand for city-centre ones – aggregate prices can increase because higher demand is priced in quicker than lower demand.

It’s also possible that even if people are correct in anticipating hard times this need not lead to weak house prices. If the Bank responds to such hard times by keeping interest rates low, there’ll be a support for prices. Granted, this is not what futures markets and bond markets are pricing in, but it is a possibility.

There’s a different reason why house prices could rise despite being expensive relative to equities. If we were to see a repeat of the 1970s when profits were squeezed by rising real wages then house prices (a claim on wages) would rise relative to equities (a claim on profits).

There is, however, no sign of this happening yet. Real wages are falling, and if economists are right and household spending rises relative to wages then profits would hold up.

There is, though, another possible support for house prices. If they were to falter, the government could take yet more measures to support it such as cuts in stamp duty or an extension of help-to-buy schemes. In economic terms, there would be little logic to such measures: for most of us, housing is not actually wealth at all. But then policy-making and economic logic are not the closest of companions.

So, the consensus that house price inflation will fall is not a wholly robust one. If it does prove wrong, though, it’ll be either because of government intervention or because something strange has happened.