The end of the house price boom is what will finally sink Brown

15 December 2007

Like Wile E Coyote, the cartoon character who stays aloft long after he has run off the edge of a cliff, the British housing market has constantly defied gravity.

After each peak house prices fell by around 30% in real terms. When inflation was high the fall in prices was less obvious than it would be in today’s low inflation environment when nominal house price falls would hurt more. So will the impact of falling house prices on the wider economy.

The consensus view in the City is that economic growth will be around 1.9% next year; but that assumes house prices are roughly stagnant in nominal terms. A decline would reduce growth further by hitting consumer confidence and reducing mortgage equity withdrawal (one of the drivers of the credit-based consumer boom). There is a strong correlation between the strength of the housing market and the robustness of consumer spending and overall economic growth in Britain. If house prices continue to fall, fewer jobs will be created and unemployment could start to rise, reinforcing the decline in the property market and threatening a vicious cycle of falling house prices and slower growth.

A weaker economy, consumer spending, pay rises and corporate profits will automatically reduce the government’s tax receipts. Public sector net borrowing has already reached a worrying £24.2bn so far this fiscal year – £6.7bn more than in the same period of 2006/07, even though the economy has been doing very well, growing by more than 3%.

The current housing slowdown has come too late to affect those figures much.

When the going gets tougher next year, the deficit is bound to surge further; it is now almost certain that Chancellor Alistair Darling will overshoot his budget deficit forecast of £38bn. The prediction by Ingenious Securities – that the deficit will reach £50bn in the 2008-09 fiscal year – was originally dismissed as scaremongering; it no longer looks so wild in the context of a drastic slowdown in the housing market.

The exchequer will also suffer from the decline in housing transactions, which is the key driver of its stamp duty receipts. The number of mortgage approvals for new house purchases fell from 108,000 in August to 102,000 in September and a mere 88,000 in October, the lowest since February 2005.