UK Housing Bear Market Threatening Economic Deflation

By: Nadeem_Walayat

May saw another sharp plunge in UK house prices towards what is likely to be termed as a mini-crash in UK housing market for the quarter April to June 08. Many homeowners who bought early into the current boom may be consoling themselves with having built up an healthy level of equity that is able to weather the downturn in UK housing market, after all someone buying 10 years ago would have racked up gains of over 180% to the 2007 peak and even after the initial forecast for a 2 year bear market if 15% would still stand to be some 140% richer.

However, as this analysis which is one of a series of articles in preparation for the extension of the existing 2 year housing market forecast to beyond August 2009, seeks to compare nominal house price gains against real-terms house price gains and the deflationary consquences thereof. The importance being on the impact on housing market sentiment, as it will not be for much longer where inflation is ignored as an important factor in the purchase of properties as it has been for the last 10 years of the UK's housing bull market.

Following the bottom in house prices in 1993, the UK housing market remained stagnant until 1996 when house prices stopped falling in inflation adjusted real-terms which is when the real low in the housing market was made. However despite the 1996 low, inflation had the effect of eroding the subsequent gains in house prices right into 1999 even though house price indices had recovered the losses in nominal terms, in real terms house prices were far away from their 1989 peak and therefore the bull market was slow to gain momentum.

As the housing market approached the 1989 peak in real terms during the bull run of 2002 which was ignited by interest rate cuts following Sept 11th, it was perhaps only at that time that inflation no longer became a significant factor in determining property purchases, much as it is today. The following 4-5 years experienced a large real terms gain of 52% above the 1989 peak. However the housing market is now not only falling at the rate of 7.5% per annum in nominal terms, but the inflation adjusted decline is at the approx rate of 12.5% per annum, implying a 24% drop over 2 years. This will see much of the real-terms gain of 52% over the 1989 peak evaporate to just 17%, with further real-term declines over subsequent years to be elaborated upon in the August forecast update to further erode this gain to virtually zero or worse.

This is highly deflationary and has serious consequences not just for the UK housing market but for the UK economy, as the housing market deflation will further erode the stability of the banking system and credit markets for many years. Whilst the Bank of England seems desperate for inflation not to take off at this point in time as a consequence of the wage price spiral. We may actually see the Government and the Bank of England adopting inflationary policies during the second half of 2009 i.e. in an about turn so as to prevent deflation from taking hold that would lead to a downward spiral in asset prices and economic activity.

Yes, the recent rise in the oil prices is inflationary, however they are a one off shock at the time they occur, meaning that in 12 months time they as if by magic disappear from the year on year inflation indices, however what permanently remains is the deflationary impact as they act as a permanent tax on the consumer unless the consumer demands higher pay which risks a domestic wage price spiral. 2009 is definitely going to be a tough jekyll and hyde year where the first half will be the fight against inflation followed by the second half fight against deflation, where the forces of deflation as witnessed by the Great Depression are far more destructive.

More Analysis of the UK Housing Market:

By Nadeem Walayat
http://www.marketoracle.co.uk

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Nadeem Walayat has over 20 years experience of trading, analysing and forecasting the financial markets, including one of few who both anticipated and Beat the 1987 Crash. Nadeem is the Editor of The Market Oracle, a FREE Daily Financial Markets Analysis & Forecasting online publication. We present in-depth analysis from over 150 experienced analysts on a range of views of the probable direction of the financial markets. Thus enabling our readers to arrive at an informed opinion on future market direction. http://www.marketoracle.co.uk

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