Is the house price boom an unsustainable bubble?

The latest Nationwide survey shows the average price of a home rose 3.4% in April
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House price figures from Nationwide building society yesterday were as exquisitely timed as they were astonishing.

News that the price of the average home surged by 3.4 per cent in the month just ended – a record increase according to Nationwide – were published just hours after the Bank of England had said the housing market did not worry them.

The City was still absorbing deputy governor David Clementi's assertion that there was no "bubble" in the housing market when the Nationwide figures arrived.

But to the homebuyer in the street it probably does look like a bubble. Prices have almost doubled in the six years since the 1990s boom began, gazumping is back according to anecdotal evidence and households are borrowing up to the hilt.

A gain in prices of 90 per cent – or £50,000 in cash terms – over six years certainly puts into the shade the gains that the average person has seen on their personal income, their share portfolio, the value of their pension or pretty much any other asset.

But does that make it a bubble? Certainly not according to Mr Clementi, who said the evidence of its very existence was "not conclusive".

He focused on the ratio of house prices to people's post-tax income which, as the graph shows, is well below the levels seen in the late 1980s.

Nationwide's chief economist, Alex Bannister agreed, pointing out the average household spends just a quarter of its income on the mortgage compared with almost 60 per cent in the 1980s boom.

It also produced figures showing that it would currently need five and a half years of the average take home salary to purchase the typical British property, compared with seven years at the peak of the 1980s housing boom.

"From these perspectives the market looks sound," Mr Bannister said. "Even if base rates rose in line with the most pessimistic view – from 4 to 6 per cent – payments as a proportion of pay would only increase to 40 per cent."

On that basis 2002 does not look like 1989. Although prices are rising at the same rate, mortgage rates are about 5.5 per cent compared with 14 per cent in 1989.

Turning the mortgage-income ratio on its head, Nationwide calculates that the average property could be worth £60,000 more than its current £100,473 price tag. "This suggests that prices will move higher without risking a dramatic slowdown," it said.

However there is a growing chorus of siren voices warning that the current level of growth points to a speculative bubble that must inevitably burst.

According to Roger Bootle, head of Capital Economics, alarm bells should be ringing at the Bank of England.

He believes that analysts are simply not looking at the right numbers. The Bank uses figures supplied by the Department of Transport, Local Government and the Regions, that weighs houses by how expensive they are.

On this basis, as the graph shows, the ratio of prices to earnings is within a whisker of that seen at the peak of the Lawson boom.

"The market needs an extended period of much more sedate increases in house prices for earnings to catch up," Mr Bootle said. "If this does not happen, then a crash is an increasingly serious possibility."

A key question, however, is what will burst the bubble. In the 1980s it was a combination of a speculative boom, which encouraged people to overextend themselves financially – followed by sharp rises in interest rates.

Analysts believe this is unlikely to be repeated – especially in the light of comments by MPC officials they are aware that current high levels of debt mean rates do not have to rise far to slow the consumer.

John Wriglesworth, housing economist at property website Hometrack, said: "The only thing that could cause a major fall would be the MPC shooting rates up by 2 per cent – which they are not going to do."

He also challenged the emphasis on the ratio of house prices to income, saying it ignored the huge amounts of equity homeowners had built up.

"Someone who bought a house for £150,000 five years ago and sold it for £500,000 can afford a house worth £600,000," he said. "That looks huge against his income but is it unaffordable? Of course not."

Most economists expect that in the absence of a shock, house price inflation will slow down as interest rates rise, the economic slowdown crimps growth in jobs and wages and high prices lock out first-time buyers.

The National Institute of Economic and Social Research forecasts house price inflation on the DTLR measure to slow to 6 per cent this year from 8 per cent last year.

"But even that is still consistent with what you could call a housing boom," said Martin Weale, its director.

Savills, an estate agency group, said it forecast house price growth slowing from its current 16 per cent level to 5 per cent by the end of the year.

It said continued price rises would be supported by a chronic shortage of property, a growing population and the strength of the labour market.

The number of new homes built last year was the smallest since 1924 while the Government has doubled its forecasts for population growth.

Even in London where prices are nearly eight times the average annual take home pay compared with a nine-fold difference in the 1980s, there is little sign of a slowdown.

Nationwide estimated there were 75,000 first-time buyers in the capital in 2001, a 26 per cent rise on 2000 – indicating there are still enough well-paid househunters out there.

The National Institute pointed out that population forecasts indicate the number of households would continue to outstrip new homes in areas such as London.

But whether there is a bubble or not, Mr Clementi's view that no rate rises were needed to curb the record growth in house prices, mortgage equity withdrawal and consumer borrowing was greeted with disbelief in the City.

"We believe the MPC should raise rates now to limit the risk of an asset price bubble and a huge build up of debt that will be a like a noose around households' necks," said John Butler, UK economist at HSBC.

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