Policymakers have reason to worry as UK housing boom shows no signs of waning | Larry Elliot

Easter traditionally marks the start of the annual home buying season, but this year potential sellers didn’t need to mow the lawn and paint the living room as the market is already hot.

Demand for property has been strong since the UK emerged from lockdown in the summer of 2020. Mortgage approvals are up on pre-pandemic levels and prices have been climbing higher and higher.

There are various measures of house price inflation, but they all tell the same story: annual increases of more than 10%. According to Britain’s biggest mortgage lender, the Halifax, the price of an average UK house has risen by just over £28,000 over the past year, which is about the same as the average wage of a British worker during the same period.

Regular readers of this column will know that for some time I have been wondering how long the boom can last and the answer seems to be longer than expected. Demand for residential properties continues to outpace supply even as interest rates have started to rise and households are facing the greatest pressure on their standard of living in decades.

The impact on living standards caused by prices rising faster than wages has weighed on consumer confidence, which could well slow the market in the coming months. Historically, there has been a close correlation between house prices and consumer satisfaction, but as Holger Schmieding, Berenberg’s chief economist, has pointed out, a big gap between the two measures has emerged this year.

There are structural reasons for the mismatch between housing demand and supply in the UK: it is a small country with a relatively high population density, tight planning restrictions and a tax system that incentivizes home ownership.

But it is important to put things in a global context because this is not a story of British exception. Over the past decade there has been a colossal global property boom that has doubled the value of residential property to $350bn (£268bn), four times the size of annual global production.

Much attention has been paid to what has happened with stock prices, but as Dhaval Joshi of BCA Research notes, the size of the US stock market (currently valued at around $45 billion) is dwarfed by the Chinese residential real estate market ($100 billion). The US housing market is worth twice the annual US GDP; China’s real estate market is worth more than five times China’s GDP.

We have been here before. In the early years of the 21st century, money poured into subprime mortgages in the United States, which became unaffordable when interest rates were raised by the US central bank, the Federal Reserve. In the escalation of the global financial crisis, the Fed raised interest rates by a quarter point 17 times, pushing borrowing costs from 1% to 5.25%. The housing market collapsed, leading to an abrupt change in policy.

For more than a decade, the funds needed to buy homes have been readily available and inexpensive. Weak growth and low levels of consumer price inflation have allowed central banks to keep official borrowing costs at historically low levels. In times of trouble, like the global financial crisis and the onset of the coronavirus pandemic, they pumped money into their economies through the bond-buying process known as quantitative easing.

Today, central banks are under pressure because high levels of house price inflation are beginning to be accompanied by high levels of consumer price inflation. In the United States, the cost of living has increased by 8.5% over the past year and in the Eurozone, prices have increased by 7.5%. The government’s preferred measure of the UK’s cost of living is expected to rise from 7% to around 9% when the April figure is released next month.

Two recent developments make matters worse: the war in Ukraine and the draconian lockdowns used in China to fight Covid-19. The first is to keep energy prices high; the second clogs global supply chains and leads to shortages.

But rising prices and the lingering pandemic are impacting economic activity as well as inflation. The International Monetary Fund will lower its growth forecasts for 2022 and 2023 in its latest global economic outlook to be released on Tuesday.

Faced with the prospect of a period of stagflation, there are no good options for central banks. Heavy-handed action of the type used in the US in the early 1980s and in the UK at the end of the same decade would reduce inflation – but at a cost.

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At one point in the boom year of 1988, UK interest rates stood at 7.5%, but just over a year later they had doubled to 15% and then were there remained unchanged for a further 12 months. The result has been record bankruptcies, record home foreclosures and unemployment above 3 million. House prices collapsed and continued to fall in real terms until the mid-1990s.

Since growth is slowing down anyway, a different approach will be tried. The plan is to raise interest rates gradually and modestly, in the hope that inflation will return to its target without crushing the economy.

There’s no guarantee it will work either, and it’s worth noting that even a modest increase in US market interest rates since the start of the year has led to a slowdown in demand for mortgages. And this happened at a time when interest rates are significantly negative in real (inflation-adjusted) terms.

What does all this mean? That means policymakers in London, Washington, Frankfurt and (especially) Beijing have reason to be nervous. Subprime was the bubble to end all bubbles. Until now.

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