Money News
While most economists expect nothing worse than a period of house price stagnation this year, economics consultant, Capital Economics, disagrees. Indeed, in view of the recent news flow from the market, coupled with growing evidence that the economy is on the verge of a sustained slowdown, it has cut its forecasts. It now expects house prices to fall 5% this year and by a further 8% in 2009, wiping out the gains of the last 18 months.
Conceding that assessing fair value in asset markets isn't an exact science, it nonetheless believes that the message from rental yields, the house price to earnings ratio and mortgage affordability, is that the housing market is overvalued by roughly 25%. If that is right, then over the next few years, there is certainly the potential for an early-1990s-style adjustment.
Many factors have contributed to the rapid rates of house price inflation in recent years. But two of the more important have been the huge demand from BTL investors and looser lending criteria. It argues that investors only have to cover any shortfall between rents and the mortgage payment each month, so poor affordability is much less of an obstacle for them than owner occupiers.
Meanwhile, the rapid growth in the size of loans relative to income has also helped fuel house price inflation. The increasingly uncertain outlook, however, has put a significant dent in demand from BTL investors and Capital expects this to be sustained.
The relaxation in lending criteria has also begun to go into reverse, as events in financial markets have led to a reappraisal of risk and restricted lenders' ability to lend. Without these two drivers, Capital expects recent falls in house prices to continue this year.
Optimists argue that lower interest rates will support the market and whilst Capital takes this on board it believes it won't be the most likely outcome this year, given that lenders looking to rebuild their margins won't necessarily lower mortgage rates as fast as interest rates.
Capital adds that sizeable interest rate cuts will only come if the economy looks set to weaken significantly, perhaps flirting with recession. In such a scenario, both a limited supply of mortgage credit and weak sentiment could dilute the impact of rate cuts on the market.
It concludes that larger price falls this year can't be ruled out. But it suspects that the correction will take time to gain momentum, as potential sellers sit tight rather than cut prices. However, if the economy remains weak in 2009 and unemployment rises, price falls are likely to gather pace and perhaps continue into 2010.
02 January 2008 © Moneyextra.com
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