The indicator accurately shows why house prices have continued to rise, whilst many commentators have year on year announced a crash was imminent, erroernously based solely on earnings to house prices. Despite recent rises in interest rates, UK house prices are nowhere near the unaffordability levels of the early 1990's. The ratio could be expanded to include other variables, such as the level of new build construction, growth in households, employment levels etc. so as to fine-tune the trend. But basically in a simple 3 variable chart the MarketOracle House price ratio is able to explain why house prices have not fallen, and are unlikely to do so despite the slump in house prices in the USA.

The chart shows why 2001 was a great time to buy as world interest rates plummeted, though at the same time, during 2001 there were countless economists suggesting that UK house prices were over valued and expensive. When in fact they were at their most affordable level in a generation, and explained the surge in house price growth which continues right up to the present day.

However, the most recent rise in interest rates to 5.25%, has taken the index out of its comfort range, which suggests a period of consolidation. So it can be said whilst interest rates remain at 5.25% the expectation is for annual house price growth in the region of 5%. For interest rates to really have a big impact on the UK Housing market, it would require interest rates of 6% or more. And today no market commentator, is forecasting a rise to beyond 6%.

Other factors which continue to support the UK housing market are -

UK Money Supply Growth
The growth in UK money supply is running at an extraordinary rate of 14%, its no wonder that the housing market continues to defy gravity and chug along the highs. This excess supply of money is the primary cause of continuing house price inflation, the effect of which is to devalue the value of the £ in your pocket.

The worlds ultimate hedge against inflation is Gold, and in gold terms the price of Houses has actually been falling for some years now, as inflation reappears on the scene. In Jan 2005 the price of an average house was £150,000, and the price of gold in sterling was £204 per ounce. Therefore average houses were valued in 735 ounces of gold. Today with gold at £346 and average house prices at £188000, the average house is worth 543 ounces of gold, a fall of 27%.

Whilst the Bank of England is able to mask the effect of this money supply inflation, then the government can keep printing more and more money to keep the illusion of strong growth continuing. However, at some point a crunch point will occur, when interest rates will be forced higher to reign in price inflation, we have already experienced the start of this in recent months with interest rates being raised to 5.25% in response to CPI hitting 3%.

The UK Economy
The economy continues to produce strong quarter on quarter growth, as Britain benefits from EU expansion, both in terms of the influx of cheap labour and in investment opportunities generating earnings for UK Business. if anything growth rather than slowing, appears to be accelerating with the final figure for 2006 expected to be revised higher to an above trend of 3% and consequently the UK will experience stronger then expected growth during 2007.

Immigration & Lack of Supply
As a consequence of EU expansion, a strong economy and liberal employment laws. There has been a large influx of migrant Labour in to the UK, in excess of 800,000 from the Accession States, this has supported the continuing demand for properties in the buy to let market, which has played an important role in supporting the housing market. This coupled with a lack of supply of new builds means that demand vastly out strips supply, and likely to remain so for the rest of 2007 and into 2008.

Conclusion
The UK housing market looks set to continue to be supported, even at these elevated levels, primarily due to housing still not having reach unaffordable levels experienced in the past, additionally the strong growth in the money supply and continuing immigration continues to support the market.. Even an expected interest rate rise to 5.75% is unlikely to effect the situation significantly. It would require an interest rate hike to well beyond 6%, before we are likely to witness a significant house price decline in the UK. This would be preceded by inflation taking off beyond 3% CPI, and would be associated with a decline in economic activity.

The UK housing market appears to be able to withstand the bursting of the housing bubble in the USA. Despite some similarities with the US, there are still many fundamental differences, which look set to avoid a similar slump in the UK for the remainder of 2007 at least. The expectation is for house prices in the UK to rise between 5% to 7% by the end of 2007.

By Nadeem Walayat

(c) MarketOracle.co.uk 2007

The Market Oracle is a FREE Daily Financial Markets Forecasting & Analysis online publication. We aim to cut through the noise cluttering traditional sources of market analysis and get to the key points of where the markets are at and where they are expected to move to next ! http://www.marketoracle.co.uk

-- Posted Sunday, 25 February 2007 | Digg This Article