House inflation fears overdone

NOT FOR nothing is economics called the dismal science. At last, four years after the recession technically ended, all the key indicators are moving in the right direction and forecasts for growth are being revised upwards.

The pick-up is happening across the board. The anaemic growth of less than 1% expected at the start of the year is now likely to be closer to 2% and the third-quarter growth figure will be the third consecutive quarter of positive growth.

But the pessimists are sounding the alarm and the reason is the housing market. This small sector of the economy exercises a huge influence on consumer confidence, as well as commanding the attention of the Treasury and the Bank of England. What followed the onset of the recession in 2008 was a new experience. Although house prices in the past had lost ground, they had never before fallen in nominal terms, so the heavily indebted personal sector felt significantly poorer.

And there is no doubt of the extent of the collapse. The most widely-used measure of prices, the Halifax Index, fell on average nationally by 20% between the third quarter of 2007 and the same period in 2012, although the fall was even more marked in some parts of the country.

The average price of a property in this period dropped from £199,765 to £160,476. From a high of 78,100 in November 2006, mortgage approvals plummeted to 17,126 two years later. Housing starts in England halved (from 160,320 to 80,690) between 2005-06 and 2012-13. Since the market failed to keep pace with the rate of household formation, it was no surprise that home ownership fell from almost 70% in 2002 to 64.7%.

And now the market has turned. Prices are up nationally by 4%. Mortgage approvals are up 9% in a year and, as the average advance is rising faster than earnings, the nervousness about overheating has returned. Just months into the real recovery, there is talk of a bubble. The chancellor’s scheme to help house buyers has added to the worries.

It does seem that these concerns are over-done. Prices are still below the 2007 peak and loan-to-value ratios on average are well under 90%. But an even more significant point is being missed. House prices on their own are not the key. It is important to factor in interest rates to get a measure of affordability – the proportion of household income needed to support a mortgage.

What is clear is that house prices have fallen and interest rates remain at historic lows. If Mark Carney, the governor of the Bank of England, is right, there will be very little movement from the Bank on rates for another three years. And it is not unreasonable to assume that anyone in a job continuously over the past few years has had pay increases. With earnings up, prices down and interest rates low, affordability has improved and there is some way before red lights start flashing.

The key is the supply of houses. There is a housing shortage: housing starts have failed to keep pace with the annual rate of household formation. If demand increases faster than supply, prices rise and the answer is to increase supply. People have to have somewhere to live. Early indications show housing starts are on the up, a rise of a third in the 12 months ending Q2 2013.

There is a long way to go in every sense before the housing market overheats. If, by stimulating demand and putting upward pressure on prices, Osborne’s scheme persuades builders to increase activity, the policy will be a success. If lenders believe the the growth prospects are positive, the supply of mortgage funds will help sustain the recovery. The benefits will be felt in the construction sector and in retail, where some 15% of sales are thought to be linked to housing.

Housing is the key component of consumer confidence and consumer spending accounts for nearly two-thirds of spending in the UK. A solid recovery needs a robust consumer sector. More now depends on builders and local authority planners to ensure a smooth upturn in housing.

Dennis Turner is the former chief economist at HSBC