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.

This decline in the market in turn will lead to job losses at estate agents. Repossessions will rise as buyers who extended themselves when base rates were 3.5% find themselves unable to meet their commitments. The Council of Mortgage Lenders expects the number of people losing their homes to hit 45,000 in 2008 from 30,000 this year but still well below a record of 75,540 in 1991.

The gravity-defying performance of the housing market over the past decade was helped by four factors.

First, a boom in the City of London; second, the influx of overseas money, particularly from tycoons from Russia, China and the oil-rich Gulf states looking for alternative assets, and perhaps a pad in Britain; third, the structural fall in nominal and real interest rates, which led to a step-change rise in housing values; and fourth, employment has been at record levels and unemployment at record lows, giving homebuyers greater confidence that they will be able to meet their payments.

But, while house prices will certainly fall over the next year, there are good reasons not to expect a crash. Previous price slumps were triggered by a sharp surge in unemployment, caused by a policy error such as membership of the European Exchange Rate Mechanism or a recession. While the housing downturn itself will hit the labour market, the global economy is so robust that Britain is very unlikely to suffer an outright recession, despite the credit crunch. At the same time, vast inflows of immigrants mean that the demand for homes is still increasing.

Official interest rates are likely to fall, which will eventually filter into market and interbank rates and mortgages. While the Bank is keen not to underpin house prices, it has already indicated two rate cuts are needed to stop a slump in inflation and growth. Foreign money will also continue to pour into Britain, propping up demand.

Last, but not least, a structural shortage of homes will continue to underpin prices. Britain has not seen nearly as strong a response by homebuilders to high house price inflation as Spain and Ireland have done, largely because of excessively stringent planning laws. As a result, in the long run, (over the next decade) property will recover and do well.