UK property bubble

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Just five years after the start of global credit crunch and the UK housing crash, it seems incongruous to be talking about another UK property bubble. It is a paradox that the UK has experienced five long years of recession – the worst decline in living standards in recent times, and yet, property prices still continue to go through the roof.

It’s symbolic of the UK’s unbalanced economy that on the one hand, we have falling real incomes, but on the other hand, property prices continue to outstrip expectations.

But, firstly, does the UK really have a property bubble?

house-prices-2001-2013q2

Prices in many parts of the country are still below the pre-crisis peak. London is the main property trouble spot.

The Office for National Statistics show average prices in London  increased by 11% in the year to November 2013. The performance of the  London housing market dragged the national house price inflation up from 3.5% to 5.4%. Also, it is luxury houses that are seeing the price rise fastest. ‘Prime’ houses worth over £1,000 per sq ft are now 27% higher than 2007. (London property market needs to be cooled, Guardian)

The UK’s geographical property bubble

ftb-house-pirce-earnings

Source: Nationwide  | House price to income

London property prices have reached a record 7.5 times average earnings for first time buyers. But, in the north, the ratio is only 3.1. By 2018, a forecast by the ‘Item Club’ predict the average London home will cost more than £600,000. That would be 3.5 times the average in Northern Ireland and 3.3 times the average in the north-east of England.

The UK property bubble is highly geographical. It is in London, the South East and other selected hotspots that house prices have risen significantly. In other areas of the country, house prices remain depressed. There is no coherent movement in national house prices. The old adage of ‘location’ remains the key issue to explain the property mystery.

Why is parts of the UK experiencing a property bubble?

  • Supply. The number of households in the UK is rising significantly faster than the supply of housing. You don’t have to be a student of economics, to know that if the demand for housing is rising 250,000 a year, and the supply is increasing by just 100,000 – this is creating a strong underlying upward pressure on prices. Supply is often cited for explaining the difference between the fate of the US housing market and the UK. The US saw a collapse in prices after the global credit crunch because there was a large stock of unsold houses. But, the UK doesn’t have that. See also – more on UK Housing supply
  • Demand from buy to let investors. Housing is still seen as a good investment. London is particularly attractive to foreign investors, looking to buy houses.
  • Inelastic demand. The housing shortage means that either options of renting or buying are financially unattractive. But, despite the record house prices, many first time buyers would like to try buying – even if it means borrowing from parents, taking out a large mortgage or getting on the governments ‘Help to buy scheme’.
  • Governments Help to buy scheme. Some analysts have criticised the governments Help to Buy scheme, which is giving help for first time buyers to get a mortgage. Essentially it is propping up unsustainable demand by enabling people to pay higher prices. It does nothing to tackle the underlying reason for the high house prices. It also reflects the piecemeal approach of the government to the housing market. Building 150,000 extra houses a year is a real political headache. Helping people borrow more is easier, but only a temporary fix.
  • See also: Why are UK prices so high?

Problems of the UK property bubble

  • Geographical inequality. Young workers living in property hotspots are facing difficulty in getting a place to live. A high percentage of disposable income is going on renting or mortgage.

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Does Temporary Inflation Cause Permanent Inflation?

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UK cpi-inflation-89-19

An interesting question at the moment is to what extent does temporary cost-push factors lead to a permanent rise in underlying inflation? Temporary cost-push factors include rising commodity prices, rising food prices, higher taxes. These goods are often volatile so the increase is often temporary. In the case of taxes, the price increases last for …

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Emerging markets crisis

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Emerging markets are defined as economies which are making the transition from a low income / developing economy to a high income ‘developed’ economy. Key emerging markets include: China, India, Brazil, Mexico. Emerging markets are mostly based in South East Asia (excluding Japan) and Latin America. Emerging markets often have a high rate of economic growth, but can be more vulnerable to crisis of confidence due to misaligned exchanged rates and/or bad debts.

In recent months, several emerging markets have seen a fall in the value of their currency due to concerns over aspects of their economy. This has led to a wider contagion (spreading of fear and concerns) to other emerging markets.

bank-Argentina
National bank of Argentina

Causes of the Emerging Market crisis

1. Individual country specifics. The crisis is partly caused by specific problems in individual countries  (e.g. Argentina, Turkey, India)

  • The worst affected economy is probably Argentina. Argentina suffered a severe economic crisis in 1998-2002 where Argentina defaulted on government (sovereign debt) and was frozen out of international bond markets. The Argentina economy did recover, but similar problems are now returning. The problem is that memories of the last crisis are fresh in people’s mind, undermining confidence in the Peso. Also, Argentina is struggling to finance its government debt.
  • Argentina is facing inflation of up to 30%. This is causing people to lose confidence in the currency (Peso). Despite restrictions on exchanging currency, many Argentinians are buying dollars on the black market (at 12 Pesos to 1 Dollar) This is a worse exchange rate than the official exchange rate of (8 to 1), but Argentinians worry the devaluation in the Peso will continue making their currency weak.
  • Foreign exchange reserves in Argentina are falling as the government unsuccessfully tries to prevent the fall of the Peso. To stem the flow of foreign exchange reserves, the government have implemented controls on buying foreign goods online, but this has also decreased confidence.
  • Rapid devaluation. Because of fears over inflation, government debt and lack of foreign reserves, the Peso has fallen at a faster rate than in 2002. This will aggravate Argentina’s inflation, (because imported raw materials will become more expensive after devaluation). However, devaluation will help Argentinian exports become more competitive.

2. Fed Tapering

The realisation the US Fed Reserve will soon begin tapering its bond purchases was a factor in precipitating some of the currency falls and concerns over emerging markets. A Fed tapering raises prospects of higher US interest rates making the US more attractive to foreign investment. Emerging markets have benefited from an inflow of capital during the US / global financial crisis, causing an appreciation in Emerging market currencies. But, this factor is now liable to be reversed.

Brazil’s President Dilma Rousseff complained recently that “the withdrawal of the monetary stimulus in developed countries” was fuelling “market volatility.”  Some have even suggested unfair currency wars.

An end to ultra low-interest rates in the US, will see capital flows return to the US. Also, in a few years, the EU could become more attractive for capital flows.

3. Fears of slower growth in China

Despite economic growth of 7 – 7.5%, some fear that the Chinese economy is hiding underlying weaknesses. Analysts jumped on a survey which suggested manufacturing output was falling in China. There are also concerns about the level of bad debts in the Chinese banking system. To some analysts, China has worrying signs of a property and investment bubble, which could burst with devastating consequences. China is important for emerging markets because it is a big purchaser of raw materials and commodities, which are a source of growth for other emerging markets. Lower demand for commodities leads to lower prices and lower incomes. China is also a big investor in emerging markets. A real slow down in China would have a big adverse effect on other emerging market economies.

However, fears of a Chinese economic slowdown may be exaggerated. A one-off survey on manufacturing output is not necessarily a reliable guide to the economy. There are hopes that the Chinese economy will become increasingly diversified and a growing Chinese middle class could become a new source of import buying, which will benefit the world economy.

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Factors affecting US Bond market

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Readers Question. The fear of rising interest rate is spooking markets in USA.  So is it because of tapering? – Less and less buying of securities. Or the rise of inflation is expected. Or is it the economy picking up? Firstly, it is important to keep markets in perspective. On Jan 24, the U.S. 10-year …

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Favourite economist and book

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Who is your ‘favourite’ economist, why? It may not be very original, but I would choose the man himself. John M. Keynes. Why? This is more interesting. Keynes was very practical. He saw a real crisis – the great depression, and he sought an effective solution. In looking for solutions he was willing to think …

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Which will be best currency for an independent Scotland?

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Readers question: Would Independent Scotland be better with the Pound, Euro or an independent currency? What are the risks for each scenario?

Scotland using the Euro

If Scotland use the Euro there will be some benefits from having a shared currency with the rest of the Eurozone.

  1. Scottish business and personal users will have lower transaction costs when travelling to Europe.
  2. Having the Euro could possibly encouraged foreign investment from European firms wishing to invest in a part of the British Isles now using the Euro.

However, these benefits of the Euro are significantly diminished by the new additional transaction costs of exchanging currency with the rest of the UK. Cross border trade with England is likely to dwarf the number of Scottish people travelling to the continent.

Also, given the ease with which business can convert currency and hedge against currency movements, I don’t feel that the UK has been at a significant disadvantage to retaining the Pound.

A much bigger issue for Scotland using the Euro is the very real concern that Scotland could face similar problems to other peripheral countries. What are the risks of Scotland using the Euro?

  • Scotland will have monetary policy set by the European Central Bank. You could argue the Bank of England don’t always set interest rates according to the interests of the Scottish economy. But, there is likely to be a greater divergence between Scotland and the rest of the Eurozone. If Scotland join the Euro and experience ECB interest rates (set for 16 countries), Scotland could face high interest rates when in recession or low interest rates when the economy is picking up with inflationary pressure.
  • Bond market. In the recent recession, the Bank of England has been active in buying government bonds. This has provided sufficient liquidity in the bond market. The consequence is that bond yields on UK debt have fallen to near record lows. By contrast, countries in the Eurozone have suffered from periods of very high interest rates. Markets fear the liquidity of Eurozone countries because the ECB has not always been willing to act as lender of last resort.
  • Note: Some countries have seen rapidly rising interest rates with reasonably low levels of government debt. Bonds spiked in Spain and Portugal, despite government debt as a % of GDP being relatively low at the time.
  • To some extent the ECB has overcome this issue by its greater willingness to intervene in the bond market. But, there is no guarantee the ECB will always have the willingness and ability to decisively intervene in the bond market.

There is a real concern that if Scotland adopts the Euro it will face two potentially very damaging problems

  1. Higher bond yields, increasing cost of debt payments.
  2. Greater pressure for austerity. Euro members have faced much greater pressure to cut government spending and balance the budget. The problem is that this pressure to pursue austerity in a recession has been economically very damaging. It has cause much higher rates of unemployment across Europe than compared to the UK.
  • Trade imbalances. Another feature of the Euro is that peripheral countries have often found themselves becoming uncompetitive within the Eurozone. For example, Spain and Greece saw rising wage rates and higher costs push inflation. But, because they cannot devalue in the Euro, they just became uncompetitive. This led to record current account deficits and lower economic growth. The process of internal devaluation to restore competitiveness has led to many years of low growth and high unemployment.

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France vs UK recovery

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Useful post from Paul Krugman about a comparison between the French and UK recoveries. It stems from comments by a Conservative cabinet minister that ‘the French economy is being run into the sand.’ For those who can’t get past the NY Times paywall, I’ll post the two graphs here. UK and France since 2010 The …

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