House prices fall by 15.9% in 2008

The price of a typical house fell by 2.5% in December, according to the Nationwide Building Society. This brings the annual rate of fall over the last twelve months to 15.9%. However the three-month on three-month rate, which smoothes the volatility often seen in the monthly numbers, shows a fall of only 4.2% in December. This is its slowest pace since May 2008. The price of a typical house is now £153,048, around the same level as of spring 2005, but still over £17,500 more than five years ago.

Commenting on the figures Fionnuala Earley, Nationwide's Chief Economist, said: "2008 has been a year of turmoil in the UK housing market. The disruption in the financial markets worsened throughout 2008 and had larger implications for the real economy than we anticipated a year ago. This time last year we expected the housing market to cool quickly as affordability was poor and economic conditions looked set to weaken, but we did not anticipate the speed of house price falls or the extent of the global and domestic economic slowdown. While we underestimated the speed and size of the fall, with the benefit of hindsight, the path of prices in 2008 is understandable. Three main factors have been behind the sharp fall in prices: credit conditions, expectations and affordability.

"Even in 2007 it was clear that affordability was beginning to act as a brake on activity and on the rate of house price growth in the market. The reduced access to credit resulting from wholesale market turmoil provided a catalyst for further declines in housing market activity. Finally, a combination of the initial price falls, widespread reports of financial market turbulence and the slowdown in the real economy prompted households to expect further price declines. As house price expectations turned negative, the incentive to enter the market evaporated and buyer demand fell accordingly. As a result, housing market activity plunged to the lowest levels ever recorded and house prices fell sharply.

...and conditions remain too volatile to produce a meaningful forecast for 2009 now ...

"Conditions remain highly volatile going into 2009, making it more difficult than usual to arrive at a specific forecast for house prices. In these unsettled times a forecast subject to frequent change could itself add to greater uncertainty.

...but general trends are clearer

"However the outlook for the economy, and consequently the housing market, can be described in more general terms. The UK and various other economies slipped into recession in the final quarter of 2008 and there is little sign that this trend will be reversed in 2009. These conditions have already prompted the MPC to cut the base rate by 3.5 percentage points, and are likely to lead to further falls in 2009 in an effort to prevent a deeper recession. It looks like 2009 will be a bumpy year for the UK economy.

Credit availability will remain an issue

"A great deal of uncertainty surrounds the matter of credit criteria and how much this is likely to continue to be an issue in 2009. The latest Bank of England Credit Conditions survey shows how credit conditions have been tightening at a slower rate over the last year. This may suggest that we are past the most severe phase of tightening and may mean some stabilisation or even relaxation in criteria in 2009. However, it is unlikely that conditions will relax to the levels seen in early 2007. While banks still felt that difficult wholesale market conditions led to a tightening in credit criteria over the three months to December, this was less important than earlier in the year. However, they felt that the weaker economy and the expectation of further falls in house prices continue to be an important factor. This illustrates that the more traditional underwriting criteria are coming into play, and will continue to act as a constraint for some borrowers, particularly those at the riskier end of the spectrum.

"Weaker demand from borrowers is also likely to be a more important factor in 2009. In terms of house price expectations, current sentiment of borrowers and lenders is still fairly low. Until the economy and the labour market stabilise, it is hard to imagine households becoming upbeat about the immediate future for house prices and this will hinder the pace of recovery. In addition, the wider economic recession also impacts negatively on household expectations of future incomes. With job security and income growth less certain, households are likely to be less willing to take on more debt.

"While house price falls are helping to improve affordability and the steep drop in interest rates will provide some further support, all of the typical affordability measures are still above their long-run averages. This suggests that prices have further to fall before significant numbers of buyers will be willing to return to the market. But, as the market adjusts, property will start to look cheaper and this will encourage more activity.

Pent up demand likely to play a part in recovery

"An important underlying factor which we expect to play a part in the recovery of the market is the likely build-up in pent-up demand since 2003. Since then, first-time buyers have made up only 33% of transactions, compared to an average of 46% since 1979. If one assumes that the same proportion of first time buyers would have liked to have entered the market, it is possible to work out how many have been "locked out". This adds up to about 750,000 buyers over the 2003-7 period, which is more than the total number of house purchase transactions expected in 2008. Clearly this estimation is fraught with uncertainty and sensitive to assumptions, but it does appear likely that a substantial pool of pent-up demand has been building up, which could make its way back into the market when affordability improves and economic conditions and house price growth expectations stabilise. Moreover, the severe cuts in house building activity since late 2007 suggests that once housing market activity does begin to rise again, the longer term supply pressures highlighted in the Barker Review could re-emerge relatively quickly. This in turn could help prices to recover more quickly.

Forecasts surrounded by uncertainty

"In these turbulent times the uncertainties around all forecasts are greater than usual. If the economy goes into a deeper recession we should expect to see a slower recovery in the cycle. However, if the economy recovers more swiftly, we may expect a faster turnaround in the housing market. Nevertheless, the short-term outlook for the housing market is fairly weak. This should not be surprising given the economic and labour market conditions we expect to face. Sharp cuts in interest rates will provide support to existing and pote potential homeowners and pave the way for the improvement in affordability which will eventually encourage buyers back into the market."