Iwas listening to a discussion on the radio recently about prospects for the housing market. The presenter was suggesting that, with house price inflation having fallen to a low and sustainable rate, the housing market would be stable for some years to come.The expert she was interviewing thought that this was unlikely, arguing that the housing market showed a long history of volatility and that it would be wrong to expect this pattern of cyclical swings to come to an end. I am not convinced that the expert was right. I am a great believer in looking at historic trends but not to try to identify some numerical pattern. Rather, it is to understand the underlying drivers of performance. Failure to analyse data correctly or draw inapp-ropriate conclusions can lead to wildly incorrect results. One only has to look at the forecasts of falling house prices made by Capital Economics to realise the limitations of the “history will repeat itself” approach. One of the prime causes of fluctuations in the housing market, particularly in the 1970s and 1980s, has been the effect of inflation on income. It was rational then for borrowers to gear their lending to the maximum in the knowledge that inflation would soon erode the burden of this debt. As a result, young householders were encouraged to get on the property ladder and buy a small property with a view to trading up as inflation allowed them to extend their borrowing. The problem for these borrowers was that interest rate rises could result in a sudden sharp rise in the cost of servicing this debt. In the late 1980s, base rate rose from 7.5 per cent to 14 per cent in 12 months. It is hardly surprising in such an environment that demand fluctuated markedly. Borrowers flooded to the market when interest rates were low and disappeared when interest rates rose. If we look at the economy now, we are in a very diff-erent position. Interest rates are not only at historically low levels but they also show every sign of staying at these low levels. With monetary policy set independently by the Bank of England, it would take a very marked shock to the system to cause interest rates to rise sharply. Perhaps the most telling evidence of this change in the economic environment is the current debate about the prospects for UK interest rates through the course of the year. Analysts who, like the Bank of England, are optimistic about the recovery of the economy believe there is no need for rates to change. Most economists think that the BoE is a little too optimistic and believe it will take a 25bp cut in the base rate to ensure that the growth rate returns to its trend level. Pessimists believe that the economy is weaker than the current data suggests and it will require a greater stimulus to bring the growth rate back to trend. They are suggesting that the base rate will be cut to 4 per cent by the end of the year. These differences in view are highly significant for money market traders but for ordinary mortals taking a longer-term view of the economy, these differences are almost immaterial. The state of the housing market and the rate of house price inflation this year are not going to be markedly differ-ent if the base rate ends the year at 4 per cent than if it ends the year at 4.5 per cent. If the housing market is going to be stable this year because there are no factors pushing the market one way or the other, the market can be expected to remain similarly steady in 2007 and beyond as the key drivers of demand continue to be funda-mentally stable. I believe this has important implications for potential housebuyers. In particular, I believe that the concept of the property ladder has become at best redundant and at worst positively dangerous. There were two factors which encouraged borrowers to take an early step on to the property ladder. First, the pervading inflationary environment of the 1970s and 1980s and, second, the lack of a suitable alternative form of accommodation to homeownership. Both these factors no longer pertain. Inflation appears to be under control and the removal of rent controls has transformed the private residential rental market. For many young adults today, the much improved standards of accommodation and the flexibility offered by rented housing makes this a much preferable form of housing tenure than homeownership. The costs of moving from one rented property to another are minimal. The costs of buying and selling property are very considerable. With the housing market so stable, it is no longer important when one buys. The costs of buying will not be significantly eroded by inflation. The costs will be much the same in five years as they are now, so the property ladder concept of buying anything now is irrelevant. What is important is buying the right property which suits your need for accomm-odation over the next five or more years. Buyers are realising this and moving to the Contin-ental pattern of buying a home later in life when they are settled and understand their longer-term housing needs.
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