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LuckyOne

Why A Little Bit Of Good News .......

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The green shootists out there are trumpeting every bit of "less bad" economic news as though a decline in the pace of economic deterioration is immediately going to bring about higher house prices.

I think that this logic is faulty as the consequences of a mildly improving situation for interest rates have not really been thought through that well. I see the following sequence of events :

- Market determined interest rates are already starting to rise due to the massive borrowing requirements of governments globally.

- When economic news stops looking completely bleak, investors will be willing to take on riskier assets and will flee the safety of fixed income instruments which will push up interest rates. This effect is being felt already as the market seems to think that we are in a very severe recession but that thermonuclear destruction of the economy has been averted.

- Rates are rising because of a supply problem (the amount of debt that governments are trying to finance) rather than an inflation problem. This is the so called "crowding out" effect. Any whiff of inflation will cause market determined interest rates to rise sharply.

- As was pointed out on CNBC yesterday, Year on year CPI in the US was at it lowest since 1950. It was 7% in 1951 as the results of an early version of QE fed through the market. Complacency with respect to the outlook for inflation based on the current level of inflation is a dangerous idea. We have historical precedent to show how quickly things can change.

- All of these pressures on market determined rates are going to eventually force adminstered rates (the base rate) higher as well. Less bad economic news will only force these rates up more quickly.

- There are many people in negative equity (10% of the housing market by some accounts) who are able to hand on grimly by their fingernails as long as they are employed and mortgage rates stay low.

- As soon as the pressure on rates feeds through into higher mortgage rates, these people are going to lose their tenous grip on their houses increasing supply.

- Employment lags economic recovery. When the economy eventually bottoms, people are still going to be losing jobs. When coupled with higher interest rates this will also result in more people losing houses as well.

At the moment, I can only see two outcomes :

- We have avoided a complete financial meltdown which, perhaps counterintuitively, will be bad for house prices because of the impact on mortgage rates and the lag between economic recovery and an improvement in the employment situation.

- We have not avoided a complete financial meltdown despite the massive efforts of fiscal and monetary policy which will be bad for house prices.

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Personal experience is telling ordinary people that inflation is going up on petrol and food. These are regular things they notice.

Govt lies and tells them inflation is low. They sooner or later must all come to the conclusion that the govt is lying.

Same about recovery. Whilst the high street is closing down, and jobs are being lost there is no recovery.

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