Stephen King: Wittgenstein has the answer to house prices

If you're a Northerner, you've never had it so good

I received a letter from an estate agent the other day. Its view of the local housing market seems straightforward enough. All rumours both of excessive strength and of suicidal weakness are, apparently, no more than media hype and can be safely ignored. Apparently "...Each hype disturbs the market. Which then takes a month or two to settle back to where it would have been in the first place."

Apart from the grammar, this is all very comforting. The estate agent goes on to say that: "Borrowing is still cheap. Barring an unforeseen disaster, our local market won't collapse."

If I follow my estate agent's logic, I have some good news for you. Because house price comments in the media are no more than hype, I can safely ignore what I'm about to write. And so can you. Far better to trust the views of a local estate agent whose employees are bound to give an objective view of the housing market than focus on media comments. Indeed, if my estate agent is to be believed, we should fill our boots with property because, in the local area, the news is still "good".

Removing my tongue from my cheek, the estate agent may, nevertheless, still be making a reasonable point. The housing market debate has gone on for a long time. Both experts and laymen have their views and, to date, no one has been definitively proved right or wrong. No wonder estate agents are happy to claim that all such discussion is no more than hype: opinion is one thing, reality is something altogether different.

Analysis of the housing market is about as straightforward as interpretations of Wittgenstein's famous "duck/rabbit". You may recall that Wittgenstein's drawing can be seen either as a duck or a rabbit (with either ears or a beak). Similarly, there's more than one way to look at the housing market. We don't always see the ambiguity of what's there: instead, we see things in the way that suits our own "world view". And an estate agent's world view of the housing market tends to be rather rosy.

Here are five points of ambiguity, areas where it would be useful to know what's going on but where the data are not sufficiently convincing.

First, there's the regional picture. If you're a Londoner, you might have spotted some signs of weakness in the past few months. Annual London house price inflation is down to about 10 per cent, well off the peaks of more than 20 per cent recorded at the turn of the millennium and, despite the optimism of my local estate agent, my guess is that the volume of transactions is now a lot lower than it was. On the other hand, if you're a Northerner, you've never had it quite so good: house prices are racing away with annual gains of more than 30 per cent, and these gains are still close to the all-time-highs recorded a few months ago (see left-hand chart).

"Regional split shows house price slowdown most stark in London". Source: Nationwide (non-seasonally adjusted).

Second, there's the ambiguity of surveys. The Royal Institute of Chartered Surveyors' housing survey - known as the Rics survey - is looking very soft at the moment. On balance, surveyors are now telling us that prices are falling nationally. But they've told us that before - most obviously in 2003 - and nothing much seemed to come from it: the Nationwide and Halifax house price indices continued to chalk up annual gains (see right-hand chart). It's true that, last month, the Halifax seasonally adjusted series fell 0.6 per cent - weaker than at any point during 2003 - but the Halifax series also showed monthly declines in 2002 that told us little about the underlying trend in national house prices.

"Surveyors point to slowdown ... again!" Source: Rics (seasonally adjusted) and Halifax (non-seasonally adjusted).

Third, there's the ambiguity of measures of demand. Mortgage approvals have fallen in recent months, pointing to a possible drop-off in demand. But they did much the same last year without there being a catastrophic impact on the housing market. New buyer enquiries are also low, but there's nothing new about that either. The number of first-time buyers is depressed but, then again, there weren't many of them around last year, and that didn't stop house prices from going up.

Fourth, there's the financial position of households. The stock of debt is now unusually high, and financial liabilities have risen more swiftly than financial assets (a clear sign that people have been borrowing on the back of house-price gains). Consumers have become housing junkies. The huge growth of mortgage equity withdrawal in recent years suggests that consumer spending has maintained its buoyancy only because of continued house price strength (another way of putting this is that, in the absence of strong house price gains, the household saving ratio would probably have been a lot higher).

Finally, there's the credit position of the housing market as a whole. Signs of excessive levels of financial distress are difficult to come by. Mortgage arrears, for example, are at record lows. Then again, they typically are just before the storm. People borrow more because they think they can afford to: it is only when their personal financial position turns sour that they start to fall behind in their mortgage payments. At the end of the 1980s, households seemed to be in a similarly prosperous position but it all came unhinged in the early Nineties.

Summing up, the data published so far are distinctly ambiguous. Areas of weakness have materialised and, taken together, they could be indicating the beginnings of a more significant housing downswing. On the other hand, these areas of weakness have been seen before and have proved temporary, having no real significance for the longer term performance of the housing market or consumer spending.

Perhaps, then, it's not so much the housing market data themselves that are the worry but, rather, the context in which they're evolving. In 2002 and 2003, there were the occasional anxious moments in the housing market but, back then, monetary policy was very supportive. The Bank of England's repo rate fell from 5.75 per cent in January 2002 to 4.0 per cent by the end of that year and to a low of 3.5 per cent in the middle of 2003. Since the end of last year, the repo rate has risen to stand at 4.75 per cent currently.

It's true that this interest rate is very low by historic standards. Nevertheless, we know that the Bank thinks that the housing market and consumer spending have been too strong. So the intention behind this year's monetary tightening has been fairly clear all along.

The problem is not so much a short period of house price weakness but, rather, the extent of the economy's overall dependency on the leverage associated with constantly rising house prices. To date, consumers have been happy to carry on spending, helped along by the borrowing that's linked to house price gains. Turn off that mechanism and the economy will face significant risks. With retail sales still buoyant in August, the recent weakness of the housing market might prove to be one more statistical blip. Should the consumer show signs of retrenching in the light of the housing slowdown, however, there will be more reasons to worry.

So is it a duck or a rabbit? For the time being, you can choose whatever you want it to be. We know, though, that the Bank is out hunting: let's hope that the Monetary Policy Committee manages to only catch, rather than kill, its prey.

Stephen King is managing director of economics at HSBC

stephen.king@hsbcib.com