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Low interest rates and a relatively low rise in unemployment have helped the property market make a soft landing - but George Osborne could spoil all that
After a housing bubble of epic proportions, the expectation was that the onset of recession in 2008 would lead to a collapse in property prices. By cutting interest rates from 5% to 0.5% in a matter of months, the Bank of England prevented that from happening because mortgage holders saw a dramatic drop in their monthly payments. With employers hoarding labour, there were neither of the ingredients – high interest rates and sharply rising unemployment – that led to the record repossessions of the early 1990s.
Instead of a blowout, there has been a slow puncture in the housing market. The number of mortgage applications has dropped by more than 50% since the peak of the boom, but house prices – after a brief rally in the second half of 2009 and early 2010 – have drifted gradually lower.
There are several reasons for this slow-motion decline. Demand for property is weak, in part because consumers are wary about borrowing money at a time when their real incomes are under pressure from a rising cost of living and higher taxes, and in part because first-time buyers are finding it hard to get a foot on the property ladder. In the bubble years, new entrants could buy homes because the mortgage lenders were offering home loans worth 100% of the value of the property, and sometimes even more than that.
Lenders have adopted a rather more cautious approach since the financial crisis, with the result that first-time buyers are now being forced to find deposits of between 25% and 30%. That takes an awful lot of doing when the average house price in the UK is still more than £160,000, unless young people are able to have recourse to the "bank of mum and dad".
If markets worked as they do in the economics textbooks, prices of houses would fall until they were back within the reach of first-time buyers. Demand would then pick up, and mortgage approvals would rise. That, though, has not happened. While unemployment has risen since the 2008 crisis, the increase has been far less marked than in the downturns of the early 1980s and early 1990s. The result has been fewer distressed sellers.
Similarly, banks and building societies have been in no hurry to turf people struggling to keep up their monthly repayments out of their homes, since to do so would lead to the property being sold for less than the asset is valued at on the mortgage lender's books. City analysts like to describe this process as "extend and pretend" – extend the length of the loan, so that the homebuyer can pay something, and pretend that the house is worth more than it actually is.
Despite this approach, transactions are still taking place, because people move, lose their jobs or die. That explains why prices are going down everywhere apart from central London, where there is strong demand from overseas buyers taking advantage of the weakness of the pound.
Two things could speed up this process of attrition. The first would be higher interest rates from the Bank of England, which would make repayments more expensive for existing borrowers and make potential purchasers even more wary about taking on fresh financial commitments. For the time being, this threat has been banished by the continuing weakness of the economy, but Square Mile pressure for higher bank rate would quickly resurface should inflationary pressures remain strong and were growth to pick up.
The second factor is the risk that unemployment will start to go up this year, with no compensating private-sector job creation for the loss of up to 200,000 posts in the public sector. George Osborne, the chancellor, is relying on the private sector being strong enough to soak up those who lose their jobs as a result of public spending cuts, but many analysts think that he is being far too sanguine about the state of the labour market. Hence the predictions of a 5% drop in house prices this year.