Easter traditionally marks the start of the annual housebuying season, but this year there has been no need for potential sellers to mow the lawn and give the living room a lick of paint because the market’s already running hot.
Demand for property has been strong ever since the UK first came out of lockdown in the summer of 2020. Mortgage approvals are up on pre-pandemic levels and prices have climbed ever higher.
There are various measures of house price inflation but all of them tell the same story: annual increases in excess of 10%. According to Britain’s biggest mortgage lender, the Halifax, the price of the average UK home rose by just over £28,000 in the past year, which is pretty much the same as the average UK worker earned over the same period.
Regular readers of this column will know that for some time I have been questioning how long the boom can go on and the answer appears to be longer than I anticipated. Demand for residential property continues to exceed its supply even though interest rates have started to go up and households are facing the biggest squeeze on their living standards in decades.
The hit to living standards caused by prices rising faster than wages has taken its toll on consumer confidence, and that may well slow the market in the coming months. Historically, there is a close correlation between house prices and how happy consumers feel, but as Holger Schmieding, the chief economist at Berenberg, has pointed out, a big gap between the two measures has emerged this year.
There are structural reasons for the mismatch between housing demand and supply in the UK: this is a smallish country with relatively high population density, tight planning restrictions and a tax system that incentivises home ownership.
But it is important to put things in a global context because this is not a story of British exceptionalism. In the past decade there has been a colossal global real estate boom that has doubled the value of residential property to $350tn (£268tn) – four times the size of annual world output.
Plenty of attention has been paid to what has been happening to share prices, but as Dhaval Joshi of BCA Research notes, the size of the US stock market (valued at about $45tn) is dwarfed by China’s residential property market ($100tn). The US property market is worth twice US annual GDP; China’s property market is worth more than five times China’s GDP.
We have been here before. During the early years of the 21st century, money poured into US subprime mortgages, which became unaffordable as interest rates were raised by the US central bank, the Federal Reserve. In the buildup to the global financial crisis the Fed raised interest rates by a quarter point on 17 separate occasions, taking borrowing costs from 1% to 5.25%. The housing market collapsed, leading to an abrupt shift in policy.
For more than a decade, the funds to buy houses have been readily available and cheap. Weak growth and low levels of consumer price inflation have allowed central banks to keep official borrowing costs at record low levels. In times of difficulty, such as the global financial crisis and the start of the coronavirus pandemic, they have pumped money into their economies through the bond-buying process known as quantitative easing.
Now central banks are under pressure because high levels of house price inflation are starting to be matched by high levels of consumer price inflation. In the US, the cost of living is up by 8.5% over the past year and in the eurozone prices have risen by 7.5%. The government’s preferred measure of the cost of living in the UK is set to rise from 7% to about 9% when the April figure is released next month.
Two recent developments are making matters worse: the war in Ukraine and the draconian lockdowns being used in China to tackle Covid-19. The first is keeping energy prices high; the second is clogging up global supply chains and leading to shortages.
But rising prices and the lingering pandemic are having an impact on economic activity as well as inflation. The International Monetary Fund will downgrade its growth forecasts for 2022 and 2023 in its latest world economic outlook to be published on Tuesday.
Faced with the prospect of a period of stagflation, there are no good options for central banks. Brutal action of the sort used in the US at the start of the 1980s and in the UK at the end of the same decade would bring inflation down – but at a cost.
At one point in the boom year of 1988 UK interest rates stood at 7.5%, but little more than a year later they had been doubled to 15% and were then left there for a further 12 months. The upshot was record bankruptcies, record home repossessions and unemployment above 3 million. House prices crashed and continued falling in real terms until the mid-1990s.
Since growth is moderating anyway, a different approach will be tried. The plan is to raise interest rates gradually and modestly in the hope that inflation will come back to its target without crashing the economy.
There is no guarantee this will work, either, and it is worth noting that even a modest increase in market interest rates in the US since the turn of the year has resulted in a softening of demand for mortgages. And that has been happening at a time when interest rates are substantially negative in real (inflation-adjusted) terms.
What does all this mean? It means policymakers in London, Washington, Frankfurt and (especially) Beijing are right to be nervous. Subprime was the bubble to end all bubbles. Until now.