Thursday, 7 October 2010

House prices drop 3.6% in a month

Today's statistic from the Halifax (prop: Lloyd's Bank) says that the average UK house cost £162,000 in September, down 3.6% from August. This means that houses now cost the same as they did in 2004 and the owner of the (mythical) average house lost about £6,000 in the month.

However, that's only according to the Halifax. The Nationwide claim house prices only dropped 0.1% over the same period.

Why the difference? Well, this blog notes that there has been a policy change in the Lloyd's Group. They no longer offer "interest only" mortgages. Now they require a repayment vehicle, such as pension plan, an endowment policy, or straightforward capital repayments every month. This makes houses less affordable, at least to Halifax customers, with a consequential reduction in the amount they are prepared to pay for a house.

Over the last decade a surprisingly large number of home-owners have opted for an interest-only mortgage. This has made housing much more affordable and contributed to a steep rise in prices between 1995 and 2007. Thus forcing ever more buyers into the cheaper I/O option. Such borrowers generally think in terms of paying only the interest on their mortgage until inflation has substantially increased the value of their house and then selling and buying a cheaper house with the proceeds, perhaps when they retire.

Of course this plan does rely on a buyer being found who is prepared or able to take on their own, larger, interest-only mortgage for a decade or two. The market had become a pyramid scheme reliant on ever lower interest rates, which for many years the government obligingly provided.

However the next movement in base rates must surely be up. The MPC met this week and today announced that rates would be held at 0.5%, but both CPI and RPI are way above the 2% target and there are big price increases coming down the line, such as a VAT rise in January next year. Unless the government really lets inflation rip rates must rise sooner or later, and if house prices are falling at 0.5% then they will fall so much harder when interest rates return to a more normal level.

That said, it's possible the government really does intend to "let inflation rip". The trouble is these days wages are globalised; they won't go up just because the prices in OUR shops have gone up. A British worker cannot have a wage rise unless his German counterpart also gets a wage rise because market share will simply move to Germany.

The way out of this is to devalue the currency. If sterling falls but the euro doesn't then the German worker has effectively had a pay rise relative to the UK. The government would love sterling to fall, but unfortunately every other government in the world is also trying to get its currency down so in relative term they are staying the same.

At the moment we're in an undeclared trade war with rest of the world where, instead of erecting tariff barriers against each other we're competitively devaluing our currencies.

The way to devalue your currency is to reduce interest rates. But this is a war we're doomed to lose (except vis-a-vis the USA) because Germany has more cutting room than us. The euro base rate is 1.0% At 0.5% we're nearly on the floor already. And with CPI above target the MPC wouldn't have the cheek to drop another notch.

The Americans have a base rate of 0.25% - they've got even less room to maneuver than us.

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