Hamish McRae: Has the market built from bricks and mortar reached a fragile peak or is it really a plateau?

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The Independent Online

Maybe, just maybe, the UK housing market has managed to end the boom with a plateau and not a slump. If so, this will be a huge achievement for the Bank of England and a huge relief for the rest of us. It matters to all Britons, homeowners or not, as the trend of house prices is such an important determinant of domestic demand and hence economic growth. But we are not out of the woods yet.

The big point here is that it is very hard to burst a bubble - if the surge in prices is indeed a bubble - slowly. There are plenty of cases of bubbles ending with a bang - hi-tech companies after 2000 or Japanese property at the end of the 1980s, for example. In both cases the booms duly ended but with a lot of collateral damage. The popping of the hi-tech bubble resulted in recession in the world's three largest economies, while the popping of the Japanese bubble was associated with a decade-long stagnation.

You can see the pattern of house price movements in the US, UK, Australia and the Netherlands over the past 20 years in the left-hand graph (developed by the economics team at ING bank). All four nations illustrate different experiences, with the last three having had some of the sharpest surges in home prices of recent years.

The late 1980s boom in the UK was mirrored by a similar one in Australia, but the Aussies managed to scramble out without any significant fall in prices, whereas we dipped well below the waterline. That was because we were forced to have overly high interest rates while the pound was part of the European exchange rate mechanism. However, Australia's more recent boom has subsquently turned to prices going negative, though only just, on an annual basis. It is not yet clear if the country can get out of this without more pain - and, of course, these are average prices. An average change of zero means that in some areas, and for some types of property, prices have indeed gone negative.

The Netherlands is interesting as it illustrates a side-effect of having the wrong monetary policy, though not so disastrously as in the UK a decade earlier. The Dutch boom came at the end of the 1990s as the country moved towards adoption of the euro. The Dutch guilder was exchanged with the euro at too high a rate, and the result was a brief boom for the economy fuelled by low euro interest rates, followed by a recession as the exchange rate error caught up. House prices, after a surge in the run-up to the switch, have remained pretty flat for three years.

As for the US, the trend was until recently one of remarkable stability overall. There have been hotspots - California and Colorado, for example - where prices have really taken off, and cool ones in parts of the South and Mid-West. But there is land in the States, unlike the UK and the Netherlands. Still, the fact remains that the US rate of increase in house prices, at over 14 per cent year on year, is approaching the peak of the markets in the Netherlands and Australia, though not in the UK.

This leads to two questions. One is whether the US will follow the experience of Australia and the Netherlands now - or that of the UK in the early 1990s. The other is what happens to us. The first is crucial to the stability of the world economy, and the second crucial to that of our own one.

On the first question, I think the key point is that it does not require a sharp fall in house prices to knock US growth. A levelling-out will do that, just as it has in the UK and Australia. The ING team calculates that if there is a soft landing in the US (ie, a gradual return to price stability), growth will slow to a bit below 3 per cent in 2007. But if there is a hard landing, it will dip to something like 1.5 per cent by the autumn of next year.

The point is that people have either been financing higher consumption by borrowing against the value of their homes, or have at least been prepared to borrow more because of the rise in that value.

Alan Greenspan, chairman of the US Federal Reserve, co-authored an article showing some calculations of the link between home borrowing and consumption. A quarter to a third of home loans had been used to finance consumption directly, while a further quarter had been used to refinance earlier borrowings for this purpose. Dr Greenspan was unusually grave about the risks to output should mortgage rates rise sharply, though he did note that the US economy was flexible when responding to pressure.

At any rate, were the US to go through a similar experience to the UK - and our financial structures and recent experience are not too far apart - then you would expect a similar slowdown to the one we are now having. That would imply slower global growth - for the US makes up roughly one-third of the world economy - but not recession.

That leads to the second question about our own market. Basically, UK home prices have been stable since last autumn. The annual rate of growth has steadily declined as the rises of spring and summer 2004 have moved out of the figures, leaving year-on-year growth at around 2.5 per cent now (see right-hand graph). There may have been some slight pick-up in the past month, following the first cut in interest rates in two years, but it is hard to be sure. Meanwhile, City forecasters are cutting their growth estimates further. The latest numbers from the National Institute of Economic and Social Research, which calculates monthly GDP, are consistent with growth of less than 2 per cent this year, while the team at Global Insight has just cut its estimate to 1.6 per cent. It points out that to reach even 2 per cent this year would require the economy to grow by 0.9 per cent in the second two quarters, which is implausible given what we can already deduce about the July-September quarter.

The big question is whether the Bank of England's Monetary Policy Committee will be concerned enough about all this to sanction another cut in rates before Christmas. You can understand the desire to pause, as inflation is above the 2 per cent target and higher than it has been for several years. But as the Bank was prepared to tighten policy even when the current inflation rate was below target, it will presumably be prepared to loosen it even when inflation is above.

Whether or not we get the next cut before Christmas, it would be surprising were there not further ones next spring, as global growth slows further. But do not expect these to lead to another great property surge. I suspect house prices have moved to a new plateau, rather than scaling a peak from which they will plunge. That would be good news for homebuyers but it would also mean that growth in consumption will be restrained for quite a while yet.

Come the revolution, we'll all be at home

It isn't, I suppose, surprising. But it is remarkable nonetheless. According to the Office for National Statistics' latest Labour Market Trends, the proportion of teleworkers has more than doubled in the past eight years. There are now 2.4 million of them, some 8 per cent of the workforce. Most of these people, 1.8 million, work from a variety of locations, using home as a base, while just over 600,000 work principally from home. The highest proportion of these workers, 10 per cent of the workforce, live in London and the South-east, while the smallest proportion are in the North-east and Scotland. More than 60 per cent are professionals, and a similar proportion are self-employed.

This has happened because of the new communications technologies. And it is happening in the most crowded parts of these islands, not the least crowded, suggesting that it is not a way of overcoming distance, but of working more efficiently.

This leads to some thoughts. The first is that we are probably still in the early stages of this revolution. In another eight years it is at least conceivable that the proportion will have doubled again, and it would be surprising if it were not, say, 12 per cent. Remember that we are still in the early stages of rolling out broadband and WiFi, which will greatly facilitate home-working.

If this is right it will also reinforce the trend towards self-employment. We are not quite at a situation where anyone with the appropriate skills can work anywhere, but the option of working for yourself is clearly a rather wider one than it used to be. People will be increasingly measured by output rather than the time in the office. A more flexible workforce will allow companies to cut costs and respond faster to demand.

Further, if the numbers of self- employed rise sharply, that will generate a need for changes in taxation and employment policies, which are still geared to people having jobs. It will also change the political balance of the land as the self-employed demand a louder voice in policy.

A world dominated by the self-employed will be a new challenge for the politicians - and one they will find rather different from the old bosses and workers scenario.

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