PropertyInvesting.net: Property Investment Special Reports

110: Which way the UK market - and why?

PropertyInvesting.net team

Very interesting times for house prices in the UK. There are signs the UK housing market is cooling – meanwhile the Bank of England surprised the market with a 0.25% interest rate hike to 5.25% in early January. This was followed by an inflation report which showed CPI inflation at 3.0% and RPI inflation at 4.4%. CPI is a full percentage point above the Bank of England’s target and very close to when the Governor is required to write a formal letter to the Chancellor describing what he is doing to control inflation.

The news about city bonuses and a “wall of money” – some £8 billion hitting the property market has helped fuel steep house price rises towards the end of 2006 in the expectation of continued rises in 2007 when this money is banked – mostly between end January and early April.

Many economists are now expecting rates could rise to 5.5% in early February because there are signs of high money supply levels, increasing wage settlements and retailers ramping up prices - and this would feed through causing inflation. The effects of higher oil and gas prices in early 2006 will feed out of the annual inflation figure which should help to moderate inflation, but there is a feeling and genuine concern that the buoyant economy is leading to increased spending patterns and retailers taking advantage of customers willingness to accept higher prices by raising their prices. The good news is, oil prices have dropped from $78/bbl to $50/bbl and wholesale gas prices from 80p/therm to 28p/therm – but it's almost as though this has fuelled growth, activity and hence inflationary pressures on this occasion.

There is also some evidence that India and China are jacking up prices, whilst eastern European labour is not as low cost as it was a few years ago – the skilled workers can now command higher wages now they are settled in the UK and the labour market remains tight.

So what does this mean for the property investing community?

1. Do not be surprised to see interest rates rise to 5.5% in February and possibly higher still by mid summer – make sure you budget for such increases in your cashflow projections.
2. Do not be surprised if house price growth drops to zero in the Midlands, North and West by Q2 2007 and moderates to say 2-5% in London and the South-East if inflation takes off in the next few months – we should see if this is the case by end February.
3. If prices fall, make sure you have enough cash in the bank to see you through any stormy period – and those with a lot of free cash and good positive cashflow would likely be able to pick up some real bargains if distressed sellers appear in the market.

It’s important though to note that, because the property market is such an important part of the overall UK economy, the last thing the Bank of England wants to see after their top priority which is inflation, is house prices crashing. Because the strength of the economy in the south (GDP growth 4.5% in London) is so much stronger than  the north (GDP 1.5 - 2%), if interest rate rose so high it stifled the London economy and house prices dropped in London – this would imply the North, West and Midlands would be sent into recession with house prices crashing. So what this means is, the Bank of England would need to keep rates at an appropriate level to keep the north growing (not in recession) but cool London – and by implication – northern house prices may drop to 0-1%, whilst London would drop to say 3-5%. So its difficult therefore to see house prices crashing in London because this would imply a meltdown in the North. This is one of the reasons why PropertyInvesting.net favours property investment in London and southern England at present – it's lower risk. Also, London and southern England is rather less exposed to higher interest rates because earnings are higher, price to earnings ratios are moderate in areas close to London and property equity levels are generally higher. The population increase, services business growth and shortage of property and land all support prices, as well as jobs growth and international business.

So - keep monitoring the news, state of the market and which direct inflation goes, because it should be critical to your investment strategy - to "avoid" buying at the peak of the market and selling at the low of the market.

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