The UK and global economy has still not recovered from the 2007-8 crash. There are promising signs such as reasonably good employment figures and rising wages but there are also worrying signs and with recovery in a delicate state, any economic shock that could have been dealt with pre credit crunch could now cause major problems. That is why mid summer Chinese stock market wobbles sent markets into panic, but as I pointed out in this column in August China and the growth in emerging markets particularly BRIC (Brazil, Russia, India and China) gave the world breathing space to reset the banking sector and move into what could be called a “hear no, see no, speak no evil” approach to economic denial.
The problem is that for every positive sign there are also many worrying signs: we hear employment is up but that high street purchases are down, we hear manufacturing confidence is high but that construction is falling. Consider this week’s news that house prices and sales in Scotland are growing strongly. Registrars of Scotland statistics show the largest increase in volume of house sales (28,000) in any quarter since pre crash 2008. Between July and September this year the overall value of sales also rose by six per cent totaling £4.74billion, again the biggest sales value of transactions recorded since 2008. But contrast this with the simultaneous news that in Scotland personal insolvencies rose by the largest number since 2008. A 39% rise between July to September demonstrates that there are still major issues within the Scottish and UK economies and that piecemeal good news stories don’t show the whole picture.
Oil prices are still depressed and that causes employment and investment problems in the North East but low oil prices help the UK economy providing a major force for holding down inflation, and if oil prices rise as expected, slowly at first then building in momentum over the next five years then inflation will also rise and with it interest rates. The Bank of England is clearly worried by rising housing prices, in London in particular, and despite the Governor issuing warning after warning about the need to raise interest rates the mixed signals from the market combined with low inflation doesn’t merit it. It is beginning to look like we are on a road with no exits that leads straight towards a housing market crash.
So how do you deflate a housing bubble? You build new affordable homes and reset the balance between first time buyers and ladder climbers but this could take as long as a decade to re-engineer the market. The UK Government’s plan for building 200,000 starter homes, and the Scottish Governments commitment to build 50,000 new affordable homes in rent pressured areas are good examples of this. You can increase stamp duty on more expensive homes again as both Governments have done but this caused a mad rush pre-legislation and sales at the top end look set to grow again after a brief summer dip.
There are several other creative ideas such as building 1960s style Garden Cities (not very austere), creating neighbourhood community building grants and a massive increase in council housing across the UK but the only tool that will really have the desired impact on London’s runaway housing market is increasing interest rates. The problem is that with inflation at all time lows, higher interest rates could lead to deflation (known in BBC news and political spin circles as negative inflation) resulting in lowering growth, business confidence, investment and business profitability, especially in retail. This would be bad news for the economy but it would be terrible news for low paid and indebted workers as it would depress retail wage growth whilst increasing the interest on mortgages and the personal debt that weighs so heavily on low income families reducing consumer spending power (the driver of UK economic growth) and inevitably increasing that personal insolvency rate and house repossessions. The UK in a state of stagflation wage depression, rising unemployment with a broken banking sector, unprecedented sovereign debt versus growth levels and the BRIC economies slowing down – a perfect storm is brewing for a double down economic downturn.
Scottish house prices are not the problem as prices are more realistically positioned in Scotland after years of slower growth than in London and the South East. London prices are continuing to outpace the rest of the UK rising by 9% in the year to September and average London house prices are now £500,000, some 15 times London’s average wage and significantly higher than the average house price for England and Wales at £186,553 and Scotland’s £166,000. Other major European cites are not experiencing such strong growth so it is clearly a London phenomenon. A more troublesome comparison is to look at prices during the last bubble in 2006 and where as London Prices are now nearly 80% above 2006 prices, New York City for example is still 16% below its 2006 high. Property prices in London are also far out performing the FTSE-100 (another strong bubble indicator) and if it looks like, feels like and acts like a bubble then expect it to bust like all bubbles do, creating a mini banking crises at a time when the banking sector cant handle a crisis.
When will that happen – well not yet, as with the correction in Asian markets the end is not nigh but if price rises are headed to 40% over the next four years then the tipping point will be reached and trigger a massive house price reduction in London putting 20-30% of mortgages properties into negative equity. Think most homes in London are bought with cash from previous house sales? Think again, 25% of the UK’s mortgage debt is on London properties. Worryingly over a third of that huge London mortgage book is made up of interest rate only mortgages buyers obviously betting the market will grow and grow and not readjust (bubble behavior) and 2017/18 will see the first major wave of principle repayments on those mortgages if that coincides with increased inflation and interest rates then repossessions will soar and prices will crash sending shock waves through the whole of the UK economy.
Looking at the economy from Aberdeen top of your wish list would be a swift rise in oil prices, looking at it from London you would hope oil prices stay depressed keeping downward pressure on inflation. It seems that in any fiscal cycle Scotland’s economic pain is London’s gain.