House prices up 1.3% in July

House prices rose by 1.3% in July, according to latest figures from the Nationwide Building Society.

Commenting on the figures Martin Gahbauer, Nationwide's Chief Economist, said: "The price of a typical house rose for the third consecutive month in July, increasing by 1.3% on a seasonally adjusted basis. The 3 month on 3 month rate of change - generally a smoother indicator of the near term trend - rose from 1.0% in June to 2.6% in July, the highest level since February 2007. House prices are still 6.2% lower than 12 months ago, but this represents another sharp improvement from the 9.3% year-on-year decline in June. Even if prices were to remain unchanged for the rest of 2009, the year-on-year rate would continue to improve since prices were falling very sharply in the second half of last year. For the first seven months of 2009 as a whole, prices have risen by a cumulative 1.3%, suggesting there is now a reasonable chance that prices could end the year slightly higher than where they started. Only a few months ago, such an outcome would have appeared unthinkable.

House prices resilient despite recessionary economic background

"House prices have been remarkably resilient so far this year, despite a recessionary economic background with sharply rising unemployment. Although this outcome has come as a surprise, it is not inconsistent with other economic indicators and asset prices, which have also bounced back somewhat after very severe declines around the turn of the year. During turbulent economic times, it is not unusual for economic indicators and asset prices to overshoot in one direction and then experience a correction in the other. In the specific case of the housing market, the very sharp decline in transactions over the course of 2008 produced a fairly large pool of prospective purchasers who were ready and able to buy in principle, but did not want to do so in the very uncertain conditions prevailing when the banking crisis was at its peak last autumn. When it became clear that government interventions around the globe had stabilised the banking system and prevented a worst-case economic outcome, some of this pent-up demand re-entered the market, with the added assistance of very low interest rates. Although the resulting rise in transactions has not been that dramatic, it has been enough to produce an upward bounce in prices because it coincided with very low levels of supply on the market.

"The improvement in housing market conditions, however, does not mean that the positive price trends of recent months can be extrapolated into the future in a straight line. If prices continue to increase at the rate of the last three months, they would soon rise to levels that would be noticeably out of line with earnings, rents and other fundamental determinants of housing valuations. One should also not underestimate the impact over time of high unemployment, which has implications both for buyer confidence and the financial pressure on existing owners to sell. It is unlikely, therefore, that price increases can be sustained for long at the very strong rate observed over the last few months.

Depth of building recession likely to have long-run implications for the housing supply

"One of the factors helping prices to stabilise in 2009 is the shortage of properties available for sale. In the short run, the supply of homes on the market is mainly determined by factors such as potential sellers' confidence in market conditions, labour market turnover or financial pressures to sell among existing homeowners. Over the long run, however, the supply-demand balance depends critically on the rate of housing construction in relation to the rate of household formation.

"The future level of household formation is a matter of tremendous uncertainty, as it depends on factors that are difficult to estimate such as birth rates, life expectancy, net migration and lifestyle preferences. Of these, net migration is one of the most important and uncertain factors. After the expansion of the European Union in 2004, net migration increased substantially, as workers in the new member states were attracted to the UK by strong labour demand and a high level of Sterling. Given the downturn in the UK economy and the fall in the Sterling exchange rate, net migration seems likely to slow somewhat from recent levels, although it will probably remain positive given the openness of the UK economy and labour market relative to other countries.

"The central assumption from the Department of Communities and Local Government is that long term net migration will be 171,500 per year, resulting in an annual increase in the number of households in England of 252,000 once other factors are taken into account. Even if one were to assume zero net migration, however, the number of households is still projected to expand by an average of 153,000 units per year through to 2031. Whatever the true number is, it is almost certain that current levels of housing construction have fallen far below future levels of household formation. Based on recent levels of housing starts, it looks likely that only around 100,000 homes will be built during 2009, which would represent by far the lowest level on record. As it is likely to take time for the economy and housing construction to recover to pre-crisis levels, the potential exists for a considerable housing shortfall to develop over the next few years. This would be on top of the shortfall that already started to develop in 2004, when even boom-time levels of construction failed to keep pace with household growth.

"The low level of current and past housing construction may help house prices build a floor following the sharp declines of the last few years, as the UK does not have the large overhang of excess construction that has plagued the housing market in countries such as Ireland, Spain and the United States. Over time, however, these shortages are detrimental to housing affordability and can contribute to future instability in prices."