It now seems almost certain that house prices have reached the top of their trajectory and are starting to return earthwards. The only question is how far and how fast they will fall and the effect this will have on the economy.
Anecdotal evidence of a stall in the housing market has been rife with many attributing overnight loss of interest from potential buyers to Mervyn King’s (Bank of England Governor) announcement that prices were unsustainably high (see story in Knowledgebase 16th June 2004).
With recorded falls in East Sussex and other parts of the country it now seems only a matter of time before Brighton & Hove follows. There is considerable speculation about the effect that this will have on the consumer activity, which is largely credited with propping up the UK economy. Over the past five years as house prices have doubled consumer borrowing has hit record levels (see story in Knowledgebase 3rd June 2004). Despite this fact, surprisingly the Governor of the Bank of England has cast some doubt on the link between house prices and consumer spending. He suggests that house prices may be correlated to rises and falls in consumer spending but not the cause. He suggests that both may be driven by a common third factor such as expectation about future income, which is not directly related to interest rates and house prices. This view has support from some quarters. The Chief Economist of Capital Economics suggests that consumer spending is actually tracking disposable income and not house price movements.
If this is the case then even quite large falls of 25% - 30% in house prices would have a very limited effect on consumption. Perhaps it was all just a coincidence that, in each of the last three economic cycles when the housing market declined sharply the resulting decrease in consumer spending pushed the economy into recession.
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