The last post examined the relationship between mortgage approvals and house prices. The results from that analysis showed that mortgage approvals lead house prices by 4- 6 months. This post will assess the relationship between the overall health of the economy and house prices.
Chart 1 GDP and House Prices
Chart 1 depicts annual change in the house price and business cycles, with the business cycle being represented by annual change in real GDP. It appears house price cycles coincide roughly with business fluctuations. Visual inspection suggests that economic activity led house prices in the early to mid 1980’s. However, post 1988, that lead-lag relationship has changed. The solid red circles highlight turning points in GDP growth that occur before the turning point in house price momentum. The dashed red circles spotlight troughs and peaks in house prices that have heralded the troughs and peaks in economic activity. It has been suggested that the link between house prices and the general economy has been altered.
It has been suggested that the deregulation of the mortgage market that began in the 1980’s, has resulted in increased competition for mortgage products; this has also increased the availability of mortgage finance to households and lowered lending standards. Consequently the demand for residential real estate has risen, culminating in rising house prices. The impact of the increased house prices and the creation of mortgage products intended for equity withdrawal have enhanced the positive influence of house prices on household consumption. In addition rising house prices also influence consumer confidence which has a strong correlation to retail sale/consumption. Recall that in the UK consumption is approximately 64% of GDP. Economic researchers have also put forth that the influence of monetary policy on housing activity has been altered. Historically it has been suggested that changes in monetary policy were transmitted to the housing sector via construction (residential). High lending costs reduces the profitability of construction projects, causing property developers to alter their supply decisions. However, it is felt that monetary policy is influencing house purchasing decisions of buyers via the mortgage market.
Chart 2 Cycles 1979, 1990 , 2008
Chart 2 shows the quarter on quarter % change in the Nationwide House price index 9 months before and after peak in Q2 1990, Q1 2008 and Q2 1979 GDP levels. Interestingly, house price began to fall 3 quarters before the peak in Q2 1990 GDP, while Q1 2000 house prices peaked a quarter before Q1 2008 peak in GDP. On the other hand house prices declined 3 quarters after the GDP peak in Q2 1979. This highlights how prices differ from cycle to cycle.
The business cycle and house price cycle roughly coincide, but the lead-lag relationship is far from static. The character of cycles is a function of the level/direction of interest rates, inflation and the level of debt accrued during the boom period. Severe financial imbalances and deleveraging may have the impact of delaying price recovery. Another factor that may cause the lead –lag relationship between GDP and house prices to vary is demand and supply imbalances that exist in the property market. Over-building during the boom period can result in an inventory overhang during the bust period as demand diminishes. Inventory overhang can act as a strong headwind for both house prices and residential investment.
More posts on the characteristic s of the economic backdrop at the time of turning points in property cycles to follow.