January 2018 newsletter – House prices and the UK economy

The surveys carried out by the Centre for Macroeconomics (in conjunction with the Centre for Economic Policy Research) are intended to inform the public about the views held by prominent economists based in Europe on important macroeconomic and public policy questions.More information about the CfM can be found at http://www.centreformacroeconomics.ac.uk.

The November CFM-CEPR expert survey explored two aspects of recent developments in UK house prices:1

• First, it considered what respondents think is behind the recent developments considering, for example, potential roles for a delayed effect of Brexit and higher interest rates.

• Second, it asked about the likely effects on the UK economy of a continued cooling of the housing market.

Developments in UK regional house prices
One view is that the slowdown in London house prices is a sign of likely future developments in the rest of the UK. Such a view stresses signs of cooling in the housing market. For example, mortgage approvals fell to 66,232 in September (a three-month low). Housing transactions decreased by 1.8 per cent between August 2017 and September 2017.2

The September 2017 RICS survey’s main indicators3 on demand and sales ‘both slipped deeper into negative territory, with this subdued picture anticipated to persist over the coming months.’ The RICS survey results also suggest that London is the weakest of the UK regions but is certainly not alone in experiencing a slowing housing market. And to the extent that the Bank of England’s November increase in interest rates is the start of a gradual normalisation of interest rates, higher mortgage costs will contribute to lower demand in the whole country.

On the other hand, some of these signs of housing market weakness are less pronounced than had been expected previously. For example, the September mortgage approvals outturn was slightly above the mean of a Reuters’ poll of economists.4 And the Bank of England’s November Inflation Report concluded on the housing market that ‘the outlook is more resilient than in August.’

There are also reasons for thinking that there are London-specific factors at work.5 For example, London may be more affected by Brexit concerns, was potentially already over-valued and is more affected by higher stamp duty on second homes than other regions.

The first question in the CFM-CEPR survey asked for views about the current outlook for the UK housing market.

Question 1: Do you agree that the phenomenon of declining house prices will ripple out from the London property market leading more UK regions to experience falling prices?

Forty-four panel members answered this question. Overall, the panel members agree with the statement; 47 per cent either agree or strongly agree (54 per cent weighted by self-reported confidence); 23 per cent either disagree or strongly disagree; and around 20 per cent neither agree nor disagree.

The macroeconomic effects of weaker housing markets
The Bank of England’s November 2017 Inflation Report states that: ‘Housing investment growth overall is projected to be fairly subdued in coming quarters.’ Historically, there is a high correlation in the UK between consumption growth and house price inflation. This suggests that weakness in the housing market is likely to reduce household consumption, as well as having a direct effect on investment.

A weaker housing market may also exacerbate already weak productivity through increased mismatch. Households that are unable to sell a property may potentially be unable to switch employment and move to a better job match without a long commute.

International evidence, however, suggests that the effects of house price depreciations are not so simple. For example, Mian et al (2015)6 find asymmetric effects in the United States of large and moderate house price depreciations. Aizenman et al (2016)7 examine a panel of countries and find a positive effect of large house price depreciations on economic growth.

As such, a significantly weaker UK housing market, especially when led by reductions in the price of property in London, may actually boost GDP growth. For example, Caballero et al (2008)8 show that falling house prices may force low-productivity firms out of the market, which would further free up bank credit to lend to productive firms. And with less mortgage lending activity, credit may be reallocated toward the commercial and industrial sectors.

More affordable housing may also make it easier for younger workers, currently renting, to move into areas with high-productivity jobs. Furthermore, a major house price correction may redistribute wealth toward the young, thereby helping to address intergenerational inequality.

The second question in the survey asked for views on the effects of a weaker housing market on UK growth:

Question 2: Do you agree that a more widespread weakening of the UK housing market will slow UK GDP growth significantly?

Forty-three panel members answered this question. 44 per cent either agree or strongly agree (53 per cent weighted by self-reported confidence), 35 per cent (33 per cent) either disagree or strongly disagree, and 19 per cent (14 per cent) that neither agree nor disagree.

The survey shows that a majority of leading economists think that the phenomenon of declining prices in the London property market will ripple out to the rest of the UK, Asked whether a widespread weakening of the housing market will slow GDP growth significantly, the experts are more divided: roughly a half agree and roughly a third disagree. Several point to uncertainty about the eventual Brexit outcome making it very difficult to engage in predictions about house prices and growth; others suggest that lower house prices could be a good thing for the UK economy, especially young people.

1.The full report, including the views of individual economists, can be accessed at http://cfmsurvey.org/surveys/house-prices-and-uk-economy

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