HAMISH MCRAE: We’ll pay for house price boom

HAMISH MCRAE: House prices cannot stay at eight times earnings, but getting that ratio back to a sustainable level will be a bumpy ride

The Bank of England is getting worried about the surge in house prices, and about time too. Prices in April were up 10.9 per cent on last year in the sharpest increase since the financial crisis of 2008. 

And last week, both Sir Jon Cunliffe and Sir Dave Ramsden – deputy governors for financial stability, and markets and banking respectively – issued warnings. 

Sir Jon thought the increases were mostly driven by the stamp duty tax holiday, but warned of ‘housing choices that may affect the future’. Sir Dave warned of the risk that ‘demand gets ahead of supply’ and pushes up inflation. 

Surge: At the end of last year, house prices were more than eight times average earnings – that is the highest it has been for 120 years.

Indeed. Take another statistic. At the end of last year, house prices were more than eight times average earnings. That is the highest it has been for 120 years. 

Homes in Britain are less affordable than they have been at any time since 1900. Fund manager Schroders has done a nifty study of the relationship going back to 1845. They spotted that this eight s. Once was around 1900, the next briefly just before the financial crash of 2008 – and now. 

This house price boom is not simply a British phenomenon. It is a global one. Prices in some other countries may be lower relative to earnings, but they are shooting up. 

According to Knight Frank, in the year to the end of March, they were up 22.1 per cent in New Zealand, 16.6 per cent in Luxembourg, 13.2 per cent in the US, 13 per cent in Sweden, 10.8 per cent in Canada – the list gives on. 

Why are prices soaring worldwide? The answer is simple. The central banks have held interest rates down to ludicrously low levels, making it historically cheap to borrow. And with quantitative easing, they have in effect printed money almost without limit. That money has to go somewhere. They have unleashed an asset price boom. Inexperienced investors have bought all sorts of flakey things such as Bitcoin. 

Wiser ones have bought homes, on the grounds that while prices may indeed fall for a bit – most of us can remember what happened in 2008 – at least they will have somewhere to live. 

The housing boom has been great for people who already own homes they are happy with. It is nice to feel a little richer. Median household wealth was £286,600 in 2016-18, according to the latest figures from the Office for National Statistics. My quick tally, taking in the rise in house prices since then, would put wealth now well above £300,000. 

It may be fine for families that are able to help their children into their first homes, but socially this is a catastrophe. Democracies cannot tolerate a situation where young people can’t afford to buy a home if they don’t have family money to get them started. 

The great puzzle is not what has happened, but why. Why have the central banks, and governments too, allowed this boom to take off? 

First, most central bankers and politicians are too young to remember the 1960s, when inflation gradually crept upwards but did not seem a serious problem until it exploded in the 1970s. 

Throughout their professional lives, the long-term trend of inflation has been downwards. Next, they were conditioned by the regime of inflation targets – introduced in the 1980s to help turn the corner – into thinking that provided current inflation remained low, they could boost their economies by loosening credit. 

Asset inflation did not matter; that was not in their mandate. Third, when the banks went on the mad lending spree that led to the 2008 crash, everyone blamed the banks and imposed all sorts of controls on them. But if banks could not lend, how was the economy to recover? 

So the authorities also started the low-interest rate, ultra-easy money policies that did eventually lead to decent economic growth. That also cut the cost of borrowing for governments that had seen their deficits soar. The policies worked. 

So last year, faced with another crisis beyond everyone’s experience, they used those policies again. But they overdid it – hence the rip-roaring scramble into real assets worldwide, including homes in Britain. 

The outcome? Interest rates will have to rise and current inflation will climb. House prices may have to come down a bit and wages will certainly have to go up. 

House prices cannot stay at eight times earnings. But getting that ratio back to a sustainable level will be a bumpy ride.

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