Given the economic uncertainty facing the UK, it may seem a little early to start making forecasts for house prices in 2012. However, Ernst & Young ITEM Club’s outlook for housing market is to see prices drop 5% in 2012. This follows on from the stagnation in prices since the 2010 peak.
It means UK prices are still lower than at the end of the 2007 bubble. However, UK house prices have fallen much less than other European countries such as Ireland, Spain, and the US.
Double Dip Recession
In the past 9 months, the economic news has largely been depressing. Economic growth has barely managed to be positive and the outlook shows subdued confidence and low prospects for growth. Despite the weakness of the economy, there seems to be little on the horizon to boost growth and consumer spending power. Both manufacturing and service sector output have shown fragile growth. Consumer spending has been kept back by a combination of higher living costs, government spending cuts and negative real wage growth.
To make matters worse, there is little prospect of seeing a stimulus to the UK economy. Growth in other countries remains weak and there is little room for monetary of fiscal stimulus given high budget deficits and continued inflation. Against this backdrop, it is not surprising that householders aren’t rushing into buying a house. The threat of unemployment and falling real wages is enough to limit demand for buying houses.
Given the prospect of a double dip recession, falling real wages and government spending cuts (which entail job layoffs) you might expect to see forecasts of rapidly falling house prices. This is especially true given the continued persistence of high house price to income ratios. For first time buyers, house price to income ratios are still above historical norms, and almost double levels at the end of the 1990s slump (in 1995, house price to income ratios fell to 2.0)
However, the UK housing market is not typical of many other countries. The persistent shortage of supply remains; it gives a curious situation where we have weak demand but persistently high prices.
The Euro debt crisis is proving much more serious than previously thought. There is a high risk of the EU being pushed into a recession. At the moment, there is strong pressure to pursue austerity measures (spending cuts) without any monetary stimulus. This is likely to lead to lower growth and therefore less demand for UK exports. Perhaps of greater concern is the exposure of European banks to government debt default. If a major country like Italy defaulted it would cause large financial losses throughout the EU banking system. This would have a knock on effect on UK lending and therefore make mortgages more difficult to get. This could push UK House prices down by 10%
Low Interest Rates in 2012.
Combined with the shortage of supply, we are likely to see the persistence of low interest rates throughout 2012. Given the weakness of the economic recovery, we are unlikely to see any demand pull inflation. Also the Bank of England are forecasting inflation to finally fall dramatically in 2012 – from a peak of 5% to close to 1%. Given this deflationary trend and low growth, low interest rates are likely to persist. This helps avoid mortgage default and makes it more attractive to buy rather than rent.
It is hard to find a parallel for such an extended period of low interest rates, but the same thing happened to Japan, and their rates have been low since the early 1990s.