Merryn's Blog

The only thing that can stop house prices from falling – more QE

A steep fall in house prices is not what the politicians want. It wouldn't do the banks any good, either. But the only way to stop it is another bout of quantitative easing.

Do we need more quantitative easing (QE2) in the UK? It doesn't really look like it, given the strong-ish GDP numbers, our rising rate of inflation and the happy news on manufacturing. But while it is true that our recovery is beginning to look like it has some traction, let's not forget about the one thing that has long been most important to UK consumer confidence (and hence to consumption and growth). House prices.

The Halifax house price index started falling again in February and is down 2.7% since then. The Nationwide index shows something similar with yesterday's numbers showing prices down another 0.3% in November. Prices are still 6-9% up on their lows, but a downward trend is beginning to be very clear (you can read more about what we view as the key housing market indicators here).

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That matters because it affects consumer spending. But it also matters, says Graham Turner of GFC, because falling house prices represent risk for the banks. That, in turn, might push up the price at which the market is prepared to lend them money. And they need the market to lend them a lot of money.

The UK's big banks need to roll over loans to the tune of £750-800bn by the end of 2012, says Turner, with the majority of that falling due in 2011. Some of the gap might be covered by rising bank deposits (if they can afford to do so, people tend to save more when house prices are falling and their pensions are under threat). But the rest will eventually have to be found elsewhere.

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And if money costs the banks more than it did, mortgages will both become more expensive and even more scarce than they are now. The result? A loop of lower lending (mortgage approvals are already horribly low down 50% since 2007) and lower house prices.

And the way to have a bash at preventing that politically undesirable outcome? A round of QE aimed specifically at pushing funding costs down and lending up.

The Office of Budget Responsibility forecasts house prices to fall 3.5% next year. Capital Economics is going for 10%. Rather like us, Capital Economics is always forecasting house price falls. But, unless we do see another round of QE (something that will be hard to justify if the rest of the economy looks OK) and unless that QE works, this time it looks like they might actually be right.

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