Outlook: A bubble or a trend? House price inflation seems unstoppable

British Energy; All change BSkyB
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The Independent Online

Common sense alone would dictate that house prices must stop rising at some stage. Yet come rain or shine, they just keep on inflating away. The latest Halifax house price index shows that after a year of gently falling house-price inflation, the rate of increase began to climb again in January, rising from an annualised 15.4 per cent in December to 16 per cent last month.

Common sense alone would dictate that house prices must stop rising at some stage. Yet come rain or shine, they just keep on inflating away. The latest Halifax house price index shows that after a year of gently falling house-price inflation, the rate of increase began to climb again in January, rising from an annualised 15.4 per cent in December to 16 per cent last month.

If any of the Bank of England's nine Monetary Policy Committee members were in any doubt about the wisdom of another rise in interest rates, these latest figures will have decided it for them. Of course, under the Government's new inflation target, which uses the European measure for inflation, the MPC isn't obliged directly to take house-price inflation into account at all. Unlike the old measure, the new one contains no element for house prices.

At the time of the switch over, it was widely assumed that house-price inflation would abate to zero over the next two years, rendering meaningless the difference between the new and old inflation target. The evidence of yesterday's figures challenges that assumption. If house prices are still inflating in two years time, the relevance of the new target will look questionable.

The Bank of England would say that even under the new method, house prices still having a bearing because the MPC must take account of their impact on domestic demand. But that's a quite tangential consideration for an asset that is key to most people's psychological understanding of inflation. For many people, the targeted inflation rate already has very little relevance to their own cost of living, with some areas of the economy inflating away at levels that would do justice to the rip-roaring 1970s.

House prices have quite plainly reached dangerously high levels, yet there appears to be nothing capable of correcting the phenomenon. To the contrary, chronic shortage of supply in combination with still incredibly low levels of unemployment seems destined to keep house price inflation in double digits.

The Government has commissioned two reviews of the housing market - one into housing finance under Professor David Miles, the other into the supply of housing under Kate Barker - both of whom are under instructions to produce policy recommendations in time for the Budget in March. Yet whatever the Government does, it's hard to imagine any short term respite. According to recent figures from the Royal Institute of Chartered Surveyors, the number of properties for sale fell by 9 per cent in the final quarter of last year. You don't have to be an economist to work out why prices keep rising.

The other factor feeding the bubble is that housing remains a highly tax-efficient way of saving. Free of capital gains tax, on first homes at least, it is no wonder that many people have come to regard their houses as their pension. The record appears to make property a sure fire winner against other forms of tax free saving.

I'm not suggesting the Government slap capital gains tax on housing; that would be political suicide for any government and it won't be recommended in either of the reviews. Yet as things stand, the housing bubble is distorting the savings market, channelling resources away from productive investment and into unproductive and existing bricks and mortar.

The key figure to look at is the average price of a house as a multiple of average earnings. In November, the last month for which figures are available, the ratio rose to 5.09 times, which is higher than at any time since records began including the last housing boom in the late 1980s. Housing seems more affordable now than it was, because interest rates are so low, but as this column has repeatedly stressed, affordability measures are largely illusion.

Initial interest payments on a mortgage may seem low in relation to income, but because inflation is also low, the real value of the debt in relation to income won't be eroded away as it has been in the past. In later years mortgage payments will absorb a greater proportion of the borrower's income than if inflation was high. For most borrowers then, the real proportion of income absorbed across the life time of the mortgage won't be any lower than it ever was.

For the many people that these days take on interest-only loans, with no obvious way of repaying the capital, the effect of this backend loading of the cost of a mortgage will be doubly burdensome. There's no point in trying to predict when the property bubble will come to an end. For the time being, demographics and shortage of supply seem to underpin the phenomenon. Yet with growing numbers of workers priced out of the housing market, it is already possible to imagine potentially serious social consequences.

Fast forward 20 years to an age when the elderly dependent outnumber the working young - the elderly in their now hugely expensive houses supported by an ever dwindling workforce of homeless taxpayers. The result: generational warfare. Any such society would be intolerable and unsustainable. It only needs to be imagined to realise that the present trend in house prices cannot possibly persist. Something will happen to end it. Yet we don't yet know what it might be.

British Energy

The more distance British Energy puts between itself and the financial meltdown which engulfed the company 18 months ago, the more questions are asked about the restructuring imposed on the nuclear generator by the Government.

Just to recap, the rescue package ended up in a massive debt-for-equity swap which left shareholders with just 2.5 per cent of the company and transferred £4bn of liabilities to the taxpayer. Bondholders and banks inherited the remaining 97.5 per cent of the shares in return for promising to exchange their bonds for paper in the new company.

The fact that those bonds are now trading well above their face value would seem to suggest that shareholders were shortchanged. Certainly that's what the US hedge fund Apaloosa Investment Management must think. Apaloosa has emerged with a 4.56 per cent stake in the company amid suggestions that it may try to re-open negotiations with the Government to secure a better deal for shareholders.

The effect on the share price has been electrifying. Since Apaloosa disclosed its stake last Friday the shares have doubled in price. Yesterday a fifth of the company changed hands. Did Apaloosa use the opportunity to bank its profit? Or has the US hedge fund increased its stake even further? And how realistic is another renegotiation of the terms so late in the day?

Shareholders have no leverage to interrupt the restructuring agreed between the Government, the company and its creditors. Voting down the deal would merely result in them losing what little equity they have left in the business. It is worth remembering too that for all the hype and hope attached to the share price in recent days, the Government will snatch 65 per cent of all future free cash flow if and when the rescue deal is finally approved in Brussels.

Private investors will have piled into the stock these past few days to judge by the volume. They may be sorely disappointed.

All change BSkyB

Another well-regarded executive is flouncing out of BSkyB, in apparent irritation at the Murdoch family's determination to perpetuate the dynasty with the appointment of James Murdoch as chief executive. Martin Stewart, the finance director, genuinely thought he was in with a shot when Tony Ball decided to vacate the hotseat, unlike the other two internal candidates, who fully understood their applications to be for cosmetic purposes only. How odd that he could have been so naïve.

jeremy.warner@independent.co.uk

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