House prices tumble as oil surges, but is there a connection?

Oil is surging, house prices seem to be in trouble, today and tomorrow I look at both, and ask: is there something they have in common? Today I will look at house prices.

Article updated: 17 May 2018 10:00am Author: Michael Baxter

First of all, here’s some hard data.

Quarter on quarter GDP in per cent

Source, Eurostat, ONS, and Note, data for Canada in Q4 not yet available.

According to the latest Halifax index, house prices fell 3.1 per cent in April. That was the biggest monthly drop since September 2010. Over the quarter, the index had a more modest 0.1 per cent drop, and year on year, prices rose 2.2 per cent.

The Nationwide index recorded a 0.2 per cent increase in April and a 2.6 per cent rise, year on year. The two indexes show different readings for April, but the longer-term trend is very similar. So, while the Nationwide did not record a drop in May, it has reported two month on month falls this year, as did the Halifax.

What they say

Do the two reports support the idea of something more serious - dare I ask: do they point to a crash?

Russell Galley, managing director at Halifax, said: "The UK labour market is performing strongly with unemployment continuing to fall and wage growth finally picking up. These factors should help to ease pressure on household finances and as a result we expect annual price growth will remain in our forecast range of zero per cent and three per cent this year."

Robert Gardner, Nationwide's Chief Economist, said: “Looking ahead, much will depend on how broader economic conditions evolve, especially in the labour market, but also with respect to interest rates. Subdued economic activity and the ongoing squeeze on household budgets is likely to continue to exert a modest drag on housing market activity and house price growth this year. We continue to expect house prices to rise by around one per cent over the course of 2018.”

In short, they agree with each other - no crash here, thank you!

Samuel Tombs at Pantheon Macroeconomics made a wider point. He said: “Looking ahead, consumers’ low confidence and modest rises in mortgage rates suggest that demand will continue to weaken. Prices will fall rapidly, though, only when a large proportion of homeowners are forced to sell up. With unemployment and borrowing costs low and credit freely available, few people are being forced to sell their homes quickly. A period of broadly flat house prices, therefore, remains the most likely outcome.”

The bellwether report

The Residential Market Survey from the Royal Institution of Chartered Surveyors (RICS) is my personal favourite gauge of the UK housing market. Its latest reading was minus eight, after being at zero in the two previous months.

The RICS index is created by asking surveyors a series of questions and for each question taking the net percentage difference. I like this index because it just seems to work. Over time, it has proven to be a very reliable indicator, not only of the housing market, but of the UK economy too. Economists famously failed to spot the recession of 2008, if instead they had looked at the RICS index, which fell sharply in 2007, and went into deep negative territory in early 2008, they would not have been surprised.

The RICS index fell back into negative territory earlier this decade too, ahead of talk of a double dip recession. In fact, I have noticed, time and time again, when this index falls sharply, the UK economy suffers a slow-down soon after, when it drops below negative the UK economy tends to slow very sharply, and if the RICS index goes into deep negative territory, the UK economy either goes into recession or flirts with it soon after.

Residentail Market Survey, headline index

Source, RICS.

The latest reading is not good - in fact it was the weakest showing since November 2012. But neither is it yet pointing to a housing crash. It would have to fall much further before that becomes a danger.

So quiet

But what it does do is point to both very weak demand and supply.

New buyer enquiries and new sales instructions - respectively good indicators of pending demand and supply - are very weak.

The stock of houses for sale is low though, which in turn is keeping a lid on falls.

The economy

The general consensus is that house prices don’t crash unless the economy is in recession. I think that claim gets cause and effect the wrong way around - or at least can do. A crash in house prices can cause a recession.

And when both demand and supply are so weak, it would not take much to kick-off larger falls.
And the UK economy is peculiarly placed at the moment. The Daily Express ran an awful lead story about booming Britain yesterday. It was focusing on the low level of unemployment. But of-course, the wider economic backdrop is poor. The economy expanded by just 0.1 per cent in the first quarter, the purchasing managers indexes suggest that April was just as weak. At last, real wages are rising again, that will help. But recent sharp falls in the pound may lead to another jump in inflation, eroding real wages next year.

UK Quarterly GDP since Q4 2002

Source ONS.

The key, of course, is interest rates. While UK rates are so low, a crash in house prices is highly unlikely. And if, as a result of rising interest rates, a housing crash looks possible, the Bank of England could always reverse course and cut rates.

But the Bank of England may not have the influence people think it has. Sometimes drivers beyond its control can force its hand.

If the UK economy remains weak, then the pound may fall further - risking a good old-fashioned sterling crisis - in such circumstances, the Bank of England may have no choice but to increase rates sharply.

If US interest rates increase at the trajectory expected, that may force the UK’s central bank to increase rates, regardless of possible negative consequences. If the Trump tax cuts, at a time of exceptionally low US unemployment, lead to a surge in US inflation, forcing US rates to rise much higher than expected, then the Bank of England may have no choice but to follow suit.

Combine this with the levels of UK debt, and suddenly a picture emerges of a very vulnerable economy. Total private sector debt is at 230 per cent of GDP, there have been only three occasions when it was higher, in 2011, 2012 and 2014, according to the IMF - although, in fairness, household debt to GDP was higher every year between 2004 and 2012.

Crash or not

The dangers I refer to here are not guaranteed to happen. If UK productivity can carry on rising, like it did at the end of last year. If the UK’s young entrepreneurs can create a more dynamic and successful economy, the dangers I refer to above, may not happen.

But there are dangers, all the same, and they are not trivial. Tomorrow, I look at deeper forces at play and draw a parallel with the oil cycle.

These views are those of the author alone and do not necessarily reflect the view of The Share Centre, its officers and employees.

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Michael Baxter

Economics Commentator

Michael is an economics, investment and technology writer, known for his entertaining style. He has previously been a full-time investor, founder of a technology company which was floated on the NASDAQ, and a director of a PR company specialising in IT.