If there are two pronounced trends in UK economic data at the moment they are rising house prices and falling inflation. Figures released yesterday by the Office for National Statistics show both: house prices rose by 3.8% in the year to September (HBOS estimate the rise at 6.9%) while consumer prices rose by just 2.2% over the last year - that’s much lower than the 2.5% expected. This is the slowest pace of price growth since 2009. This sounds like good news and in many ways it is. Today’s earnings figures, also from the ONS, show earnings growth of just 0.7% over the last year. Prices have been growing faster than earnings for the past six years meaning the cost of living is going up in real terms. Lower inflation would lessen that real impoverishment that the average household is suffering although earnings growth needs to pick up for it to dissipate completely.
Inflation is an invisible factor that greatly influences the success or failure of a property purchase. Whilst it is natural to think about a property in terms of what you can afford today, i.e. interest costs relative to disposable income, inflation will have a big impact in determining how indebted you feel over the course of the mortgage.
The average property in the UK costs approximately £170k according to figures from HBOS (up about £10k this year). Back in the golden age of inflation, the 1970s, inflation ran at an average of 12.5% per year. A loan of £170k in 1970 would have been worth just £50k by 1980 in real terms (after inflation adjustment) – inflation was the invisible friend helping you pay-off your mortgage. In the 1980s inflation averaged 7.5%, in the 1990s it was 3.5% and since 2000 about 2.5% (all using the retail price index to measure inflation). A £170k debt discounted at the average rate of inflation over the last year would still be worth £130k. Those about to buy a house will already resent the increases in house prices, but they should also spare a curse for low inflation.
Most economic forecasters are looking at better GDP figures and the booming housing market and are forecasting an increasing likelihood of an interest rate hike. But with year-on-year earnings growth is still running at less than 1% surely that’s the last thing households need. Bank of England figures show households overpaying on their mortgages faster as the economy recovers, despite historically low interest rates. To my mind that suggests that the average household has a better understanding of economics than the average economist.