The last post focused on the relationship between inflation and interest rates. This post shall review the relationship between inflation and house prices. Also a brief analysis of volatility in both house prices and goods and services inflation will be presented.
Chart 2 below demonstrates the relationship between house price inflation (HP) and general inflation. It highlights that the peak and troughs in the growth rate of house prices occur before peaks and troughs in the growth of the retail price index.
Furthermore, table 2 highlights the correlation coefficients between house price growth and inflation rates. Further, the intensity of correlation between the Retail Price Index and house prices is relatively weak. Please note that the annual and quarterly are rolling changes.
TABLE 2 Contemporaneous Correlations between RPI and House Price
Inflation, as we know does affect the real return on an investment. However, I am uncertain whether households consider real returns when buying a house for consumption and not for investment.
In the 2 previous posts http://wp.me/pTU04-1S and http://wp.me/pTU04-3c the Great moderation has been mentioned. This blog looks at volatility of house prices and inflation. Chart 2 below presents the rolling 20 quarter standard deviation of the Q-o-Q change in the retail price index and the Nationwide House Price index. This methodology is adopted from Peter Summers , http://tinyurl.com/389qfjz ,review of the causes of the Great Moderation. However, the Summers’s paper did not provide an analysis of price volatility of assets, as this post has done with house prices.
Chart 2 Volatility of House Price Growth and General Inflation
House price volatility does not show similar levels of moderation as that seen in inflation and interest rates. Could it be the reduced uncertainty around the direction of interest rates and inflation as culminated in rising house price volatility? Some economists suggest that the view that interest rates, inflation and GDP were more predictable resulted in a decline in a risk aversion. This in turn resulted in a decline in yields/capitalization rates that led to inflated asset prices. Interestingly, the period from the late 1950’s to 1970s is characterised by low volatility for both general and house price inflation. The reasons for this warrants further investigation/research.
In summary, the intensity of correlation between house prices and general inflation is relatively weak. Additionally, the annual change in house price seems to lead retail price changes. Also while volatility in house prices has increased, inflation volatility has decreased. It will be interesting to explore the potential explanation for the rise in house price volatility.