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Scorn at claim house prices 30% too high

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Matthew West

Recent claims by banking giant HSBC that house prices in Britain are overvalued by about 30% have been met with scorn by some in the mortgage industry.

The report from the bank's chief UK economist Karen Ward, gave warning that an imminent property downturn would cause sterling to plummet and force the Bank of England to slash interest rates aggressively.

The bank tried to model what it called the fair value of housing based on expected future rental growth, according to newspaper reports. HSBC refused to provide Mortgage Distributor with a copy of the original report, as it claimed the data was for use by institutional investors.

However, The Times reported Ward, the report's author, as saying: "There is around 30% of the current house price level that cannot be explained."

The findings echo those of the International Monetary Fund, which claimed in October that homes in Britain were overpriced by up to 40%.

The HSBC report says the credit squeeze could now prove the trigger for Britain's housing slowdown. It says higher mortgage costs will spark repossessions and make buy-to-let a poor investment. A slowdown in residential construction and consumer spending would then follow, causing growth to fall to its lowest level in a decade.

The Times reported that HSBC is now predicting interest rates will fall far lower than the market expects, from 5.5% at present to just 4.5% by the start of 2009, while sterling is tipped to tumble against the dollar to below $1.80.

Ward was quoted by The Times as saying Britain's spell of house price inflation, which has seen prices triple in 10 years, began as a rational response to the improved economic climate following independence for the Bank of England.

It quotes Ward as saying: "But as global investors and UK households shied away from corporate equities following the equity crash in 2001-02, they noted the rapid gains in UK property prices.

With the expectation that house prices would continue to rise rapidly, and a banking system awash with cash and willing to lend, the buy-to-let market boomed. That, in turn, led to expectations of further price gains. The bubble was born."

Contrary to the view that supply shortages have forced up prices, Ward argues that since 2000, UK home-building has increased by the same amount as in the US, which now has an oversupply of properties and falling prices. Had there been a true supply shortage, rents would have been pushed up, but rental growth has, in fact, been mild.

However, economist John Wrigglesworth called the report "headline-grabbing claptrap", adding that it was "very naïve analysis".

And research from buy-to-let lender Paragon shows rental yields have held steady at around 6% year-on-year since October 2005, suggesting the buy-to-let market is stable.

Wrigglesworth says the analysis by HSBC is likely to be flawed, arguing the report is "probably going back and relying on historical data". He argues house price inflation will probably be 0% next year, but that a house price crash of 30% ignores the shape of the current market.

He adds: "We have reached a high plateau but will probably bump along that high plateau. Transactions are around 30% down but house prices won't fall by that percentage."

The most recent official figures from the Land Registry show house price inflation rose by 8.1% for the year to October, although this was the slowest rate of property inflation since December last year.

October, however, also saw London prices fall by 0.6%, compared with an overall rise in the average UK house price of 0.1% for the month - thanks to property price rises in most other regions of England and Wales.

A drop in house prices in London is generally considered the first warning of a downturn in prices nationally, and it was the first monthly fall in the capital since April 2006 and the sharpest such drop since August 2005.

Other house price indices show prices falling, but not dramatically - Nationwide and Halifax have revealed a drop in house-price inflation of 0.8% and 1.1% respectively for November.

Martin Ellis, chief economist at Halifax, blames the recent slowdown in the housing market on the increase in interest rates between July last year and this.

He adds: "As expected, the annual rate of house-price inflation has fallen in recent months as the strong monthly house-price gains during the autumn of 2006 have dropped out of the year-on-year comparisons. The annual rate eased to 6.3% in November from 8.9% in October. This steady easing of house-price growth during 2007 is now widely expected to continue."

But he adds: "A robust UK economy and the accompanying sound health of the labour market continue to provide strong underpinnings for the housing market."

Importantly, he says "there is a fundamental supply and demand imbalance in the UK that simply does not exist in the US.

"The ongoing inability of the rate of house-building to match the pace of new household formation and pent-up demand from a large number of potential first-time buyers will also support house prices."

Halifax calculates the government's target of building three million new homes by 2020 is more than 500,000 short of what will be required based on current official household projections.

Moreover, these household projections are likely to be revised upwards to reflect the recent significant increase in the government's population projections, implying the housing shortfall will be even higher than current estimates.

That said, the impact of the credit crunch on investor confidence is clear. The latest Lloyds TSB survey of investor confidence shows one in five stock market investors have moved at least some of their money into more cautious investments such as cash or bonds over the last three months.

Over a third (36%) of all respondents said they also felt apprehensive about stock market investments over the coming year, while just over a quarter (26%) said they feel confident.

In addition, the latest Nationwide Consumer Confidence Index for November shows that confidence fell by 12 points to 86 in November. This is the most it has ever fallen in a month. The lender says the fall was not unexpected given the spate of gloomy news over the past few months.

Nationwide chief economist Fionnuala Earley adds: "Uncertainty about the effects of the credit crunch together with rising oil and food prices seem to be affecting feelings about jobs and the future economic situation.

"Going into 2008, the expectation of at least two cuts in the base rate should begin to take pressure off finances and restore some confidence."

Consumers now expect house-price growth over the next six months to be just 1.2% - down from 1.9% in October. But Nationwide says this is in line with its own expectations and is consistent with its forecast of 0% house-price inflation next year.

So are there any certainties about 2008? Take into account HSBC's own exposure to the global credit crunch, and its pessimism about next year might be more understandable. The body of evidence that suggests a dramatic fall in house price inflation and overall confidence in the housing market is not yet that great.

But public perception that the market is faltering could mean the UK talks itself into a much more damaging environment, when even the conservative predictions of both Halifax and Nationwide are jumped on by the national press as signs of a faltering economy and lead to calls for further cuts in interest rates by the Bank of England.

Maybe the only certainty about next year is that there will be a great deal of uncertainty.

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