Update on real house prices
Readers familiar with our measure of real house prices relative to trend will know that this peaked at a level very similar to two previous house price cycles but then remained there for much longer than in the past, propped up by easy money, as neither policymakers nor bankers saw the danger signals. After 12 months of falling real prices (through September) the ratio is down from 132 to 112. This is not much consolation as real prices are likely to fall well below trend before recovering.
The regression trend since 1957 is 2.8%. In a deep cycle, this regression trend rate may fall back, with more data, to about 2% pa which persisted for much of the data history. Between about 2 and 2.5% the trend is very close to real personal incomes growth, which is logical.
A deep down cycle seems inevitable given the impact of rising unemployment on overstretched personal balance sheets, whatever happens to interest rates. But if general inflation turns to deflation for a period, the squeeze on borrowers will increase as real interest rates will be very high relative to real incomes.
We have been predicting a nasty cycle since real prices first became extreme. Now it seems possible even the previous corrections, of between 20 and 40%, will be exceeded. We have also been predicting that this would be the first correction in real prices not to be concealed by high general inflation.
The light at the end of this particular tunnel is not a return to normality but the realisation by both policymakers and households that house price inflation is not a source of wealth.