Get ready for a fresh slide in British house prices

London property prices have held up surprisingly well since the financial crisis. But that could be about to change, says Matthew Partridge. And it won't just be the capital that suffers. Here's why.

You've probably noticed by now that we think British house prices are still too expensive.

Prices have fallen in many regions, and by and large are still well down on their pre-crash peak.

But with the Bank of England keeping the market artificially propped up with low interest rates, house prices are still well out of line with incomes.

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Nowhere is this clearer than in London. Property prices in the capital are in many areas back to their peak prices, or even higher.

This shouldn't come as a surprise. No sector of the economy has benefited more from bailouts and quantitative easing (QE) than the City. Banks have been shielded from much of the economic pain as bonuses continued to flow.

But times are changing. Life is getting much tougher for the banks. And that could trigger a long-awaited correction in London property.

As the City is squeezed, expect London property prices to fall

It seems that the pain being suffered by the real' economy is finally starting to make itself felt in the financial industry. Investment bank UBS recently announced it will cut 10,000 jobs worldwide, many of them in London. And this is only the start.

The Centre for Economics and Business Research (CEBR) thinks a further 12,476 financial sector jobs will be lost next year, with more to come. The fact is, with investors rattled and paralysed by fear, there's just not enough work to go around.

"Equity trading is down 20% in value year on year; gilts trading is down by a third, currency trading is down 5% this year the first fall since 2009. Merger activity is down by a third in the UK, and even more worldwide. Even the formerly dominant derivatives sector is also down by around a fifth so far this year".

The bonus bonanza days are gone too. The surviving bankers will earn less, with bonuses set to come in at just 15% of the level they hit at the peak in 2006.

We're not saying that any of this is bad news. Before the crisis, the financial sector grew far too dominant on the back of cheap credit. Shrinking the City is a key step in getting back to having a more balanced economy.

But like it or not, this is going to have a big impact on London's economy. The CEBR has cut its estimates for London's growth to just 0.2% this year and 1.1% in 2013.

It also means that there will be fewer massively wealthy individuals looking to stick big bonuses into London flats and homes. And we could already be starting to see the effect of that.

If you just look at the big house price indices on an annual basis, then the capital still seems to be doing well. According to Nationwide, London prices are up 2.1% year-on-year, making it the best-performing region in the country. The Office for National Statistics (ONS) reckons the rise is even stronger, at 5.2%.

However, the trend is turning. On a quarterly basis, Nationwide estimates that prices have fallen by 0.4%, which leaves London one of the more poorly-performing areas.

And according to the ONS, prices fell by 1.2% in September, and are now at their lowest since June. That compares to a 0.2% fall for the UK as a whole.

There are also signs of wobbles in the rental market. Rents have risen by a third since 2009. But estate agent Knight Frank says that prices at the top end of the market (£500 a week or more) are starting to decline.

Inflation is crushing the consumer

With the City under pressure, we suspect this is just the start of a longer-term slide. But it's not just London that's feeling the pain. The national market is also looking weak.

This summer there was a dramatic drop in new mortgage lending. Bank of England data shows that the total value of lending secured against housing is down nearly 10% on the start of the year. The number of loans being written each month is down 13.1% (16.5%, if you exclude remortgaging).

Given the state of the UK economy, it's a wonder the market has been holding up at all. The latest data suggests that the Olympics-inspired rebound that we saw in the third quarter won't last.

Consumer confidence remains low, and fell further in October. Activity in the services sector is at its weakest since December 2010 it's still growing, but only just. And retail sales data out yesterday was awful down 0.8% in October, far worse than expected. Mervyn King, the Bank of England governor, is now warning of a potential triple dip' recession.

There's a clear culprit for all this inflation. Even judged by the official measure, inflation rose by 2.7% in September. This remains well above average pay rises. So most people are still seeing their income fall in real terms (ie their wages buy less today than they did last year). With credit tight too, there's simply no money available to spend. Yet the Bank of England is emphasising that it might do more QE, which would only make this worse.

With consumers squeezed between falling wage packets and tougher credit conditions, it's hard to see how house prices can be sustained at current levels. With London weakening now too, a fresh slide could be on the cards for 2013. As for Britain's economy in general, we think there could be much tougher times ahead. You can read why in the latest issue of MoneyWeek magazine, out today. If you're not already a subscriber, subscribe to MoneyWeek magazine.

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Dr Matthew Partridge

Matthew graduated from the University of Durham in 2004; he then gained an MSc, followed by a PhD at the London School of Economics.

He has previously written for a wide range of publications, including the Guardian and the Economist, and also helped to run a newsletter on terrorism. He has spent time at Lehman Brothers, Citigroup and the consultancy Lombard Street Research.

Matthew is the author of Superinvestors: Lessons from the greatest investors in history, published by Harriman House, which has been translated into several languages. His second book, Investing Explained: The Accessible Guide to Building an Investment Portfolio, is published by Kogan Page.

As senior writer, he writes the shares and politics & economics pages, as well as weekly Blowing It and Great Frauds in History columns He also writes a fortnightly reviews page and trading tips, as well as regular cover stories and multi-page investment focus features.

Follow Matthew on Twitter: @DrMatthewPartri