High House Prices Leave UK Property Market Vulnerable

High house prices leave the UK property market vulnerable to a potential ‘downturn’ but the latest credit crunch is unlikely to provide a catalyst, a member of the Bank of England’s Monetary Policy Committee said on Tuesday.

Kate Barker, the longest-serving external MPC member who has written widely on housing, said she would be looking closely at house prices and at business surveys following the recent financial turmoil to help her gauge whether the economy was slowing more than expected.

The comments suggest she will use these indicators to clear the fog surrounding economic prospects and vote for a cut in rates if the data weaken.

House prices are above normal levels and therefore are somewhat vulnerable to a major change in expectations about future prices.

The recent havoc in the credit markets was not an obvious trigger as a rise in unemployment is not expected and consumer confidence has so far remained strong. The housing market is yet to see a firm slowing down of property prices.

A decline in demand for buy-to-let mortgages – some 12 per cent of the total in the first half of 2007 – might lead to first time buyers also “deferring their entry into the market although that depended on whether they expected prices to drop.

The problem is the uncertainty that clouds the outlook a view that is shared by many of the housing market bears who are reluctant to predict a downturn until they see an unjustified optimism about the property market.

Kate Baker is sanguine about the economic effects of a housing downturn because she thought households had little reason to expect their incomes, in aggregate, to fall. “In present circumstances, it is changes in credit conditions which are expected to impact house prices, and in this case a relatively muted response of consumption to changes in house price inflation might be expected,” said Ms Barker.

She also thought slowing home building resulting from a housing downturn would have only a small impact on the economy since it represents just 3.5 per cent of gross domestic product in 2006, compared with 4.5 per cent in 1988 and 5.8 per cent of GDP in the US last year.

Ms Barker, a former chief economist of the CBI employers’ organisation, said she was looking closely at the surveys she used to produce to help guide her interest rates votes at the moment.

Contrary to the impression that business expectations’ surveys always over-react to financial market turbulence, she said that they had a better, more mixed record.

Comparing business survey results and the eventual economic outcomes after sterling was ejected from the European exchange rate mechanism in 1992, the Barings collapse in 1995, the 1997 Asian crisis, the collapse of the LTCM hedge fund in 1998 and the 9/11 terrorist attacks, Ms Barker found business surveys to have painted a reasonably accurate picture except in 1998.

“This suggests that business surveys should be given weight in judging the impact of recent events for the wider economy, although the events of autumn 1998 argue for caution if the surveys fall abruptly,” she argued.

That business surveys had not fallen far this autumn was encouraging for Ms Barker and she added that weaker sterling and rapidly rising commodity prices “remain a concern”.

That said, she was now concentrating most on the risks of a downturn, in contrast to August, when the concern was that a slowdown “might not materialise sufficiently to reduce the upward inflation pressures”.