Another house price slump could make Osborne’s job much harder

I’ve just read an interesting piece of research from Capital Economics.

The Office for Budget Responsibility (OBR) – the newly-formed body which is meant to be a neutral observer of the British economy – is nothing if not thorough. The OBR’s forecasts include details of house price growth predictions. It expects prices to rise by 5.9% this year, 1.6% next, 3.9% in 2012, then 4.5% thereafter.

Those are hardly increases for property investors to get excited about. And we think even those forecasts are too high for reasons we’ve reiterated over and over.

But another reason to be sceptical is this: “Combined with the OBR’s forecasts for average earnings, these [house price] forecasts imply that the ratio of house prices to earnings (HPE) is set to stabilise at 5.3,” says Paul Diggle of Capital Economics.

Trouble is, the long-term average HPE is 3.7. As Diggle notes, “the OBR seems to be suggesting that there has been a structural shift to a sustainable HPE that is over 40% higher than the historic average.”

What accounts for this? Not ultra-low interest rates – the OBR sees these rising by next year. And the OBR doesn’t make any allowances for poor credit availability either. Yet mortgage lending is still running at around half of what it was before the credit crunch – the latest figures show that mortgage approvals are sitting at around 50,000 loans a month. And with the economy looking frail, and Bank of England support set to be withdrawn from the mortgage market, there’s no real reason to expect banks to suddenly loosen the reins.

In short, the OBR’s likely to be disappointed. And if it’s disappointed on house prices – a key driver of consumption growth in the UK – chances are it will be overly optimistic on the economy too. That could make George Osborne’s job of cutting Britain’s deficit even tougher than it currently looks.