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Economy in Brief

RICS Survey Shows Weakening U.K. Housing Market
by Robert Brusca  August 4, 2022

With the Bank of England hiking its key rate by 50 basis points and planning to squeeze its balance sheet, the U.K. housing market (the RICS survey covers England and Wales) has been reacting to the central bank's tightening; expectations for prices three-months ahead have lost a lot of momentum. The chart looks at house prices over the last three-months comparing them to expectations for the prices over next three-months. While current prices have begun to soften slightly, there's a much bigger impact on prices expected over the next three-months.

If we rank performance of the last three-months historically, it ranks in the top seven percentile of where prices have been over the last 23 years. And if we rank current house price expectations on that same timeline, they have a 44-percentile standing, below their median (the median stands at a 50-percentile ranking). And this, of course, is occurring in an environment where inflation is hot and is driving prices in the economy higher.

House prices are affected by inflation, but they're affected more immediately by interest rates when there are consequences for mortgage rates. When mortgage rates rise, house payments rise at every given price for housing. And in a market that may have gotten a little overripe with housing prices ramping up in a slightly inflationary environment, an acute vulnerability can develop. Houses can become overpriced or ‘fully priced’ such that increases in official rates can have an outsized impact on the market. Rising mortgage rates would take an already fully priced housing market and create a financing burden for new buyers, depressing prices and sales. And for existing homeowners (well, partial ‘owners’), who are paying their mortgages at variable rates, payments will go up as well.

The Bank of England’s 50 basis-point hike is the biggest hike since 1997. And it's occurring in an environment with a good deal of inflation and where the Bank of England thinks that inflation is going to escalate further before it's able to gain control of it because of past increases in energy prices. Currently the Bank of England looks for its consumer price inflation to peak at just over 13%. Previously had expected the peak to occur at 11%. This is the major reason for the Bank to have adopted the 50-basis point rate hike in August.

Sales expectations have been hit hard, too. Sales expectations had been at a net of +9 in the RICS survey back in April, but in June that figure sits at -9 and has a 9% queue standing which means that it has been weaker historically only 9% of the time over the last 23 years.

New sales are also weakening. But the series ‘new sales’ has been a peculiar series that was extremely strong in May 2021 but then by July had slipped into relatively deep negative readings and then made some recovery posting positive readings in February and March of 2022. However, since then, it has slipped to a reading of -4 in April, to -5 in May, and to -13 in June. The -13 reading has a 23-percentile standing in its queue of data back to 1999. That means that sales were weaker than this about one-quarter of the time historically. And this is only the impact on current sales; sales expectations, as we mentioned above, are still being reduced. We are going to see weaker readings in the months ahead.

The economy is under stress and there are some expectations of a recession. The GfK consumer confidence rating for the U.K. slipped to -41 in June from -40 in May. The reading had been at -38 in April. The 12-month average is -22. Clearly, this series has been slipping significantly in recent months. In June, it has fallen to its all-time low since 1999.

Table below shows the correlations among these variables. Price expectations and sales expectations, for example, have a 0.64 correlation. When prices are expected to rise, sales are generally expected to rise as well. The same is true of prices: a price in motion is expected to stay in motion- it’s a Newtonian process. The prices-to-expected-price correlation is a sizeable 0.87. New sales and price expectations have a correlation of 0.64. Sales expectations and actual new sales have a correlation of 0.72 attesting again to the impact of momentum in housing. When housing sales are strong, they're generally expected to remain strong in the future. Price expectations have a 0.47 correlation, nearly a 0.5 correlation, with consumer confidence.

However, consumer confidence does not have a very strong correlation with past gains in housing prices or with sales expectations; the correlation with current sales is negligible.

Housing market participants treat the housing market as a special entity. Economists may talk about confidence boosting housing sales, but consumers treat housing as though it's something separate and not closely linked to the general confidence barometer. Increases in confidence don't necessarily increase their activity in the housing market or their expected activity or their expectations for prices, at least not very strongly.

Attention is now going to turn to the Bank of England and to its policy of raising rates and shrinking its balance sheet. The United Kingdom is another economy, like the United States, and like the European Monetary Union, that is on recession watch. Central bankers are trying to convince us that they can gain control of inflation without creating recession, but the existing low yields in global bond markets at a time that inflation is running at an extremely high pace would seem to present the different assessment. Recessions stop inflation. If there's a recession, inflation will be terminated. The fact that bonds are trading with low yields suggest that they expect inflation to be brought to heel quickly. There's a very bad record for central banks of reducing the inflation rate by raising interest rates and avoiding recession. Statistically it's almost as bad as going to Las Vegas and trying to draw to an inside straight. It’s not impossible, but it is not a time-tested strategy for success either.

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