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Bidin'matime

Inflation As Collateral Damage?

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On the Newsblog the thought has been raised that the government might simply raise their target inflation rate rather than see interest rates rise. This could be attractive to the masses, rather than see their homes fall in value. The main pointer that I see to HPC is the house price:earnings graph, suggesting that prices will fall in real terms by about 50% in due course. But the same effect could be achieved by holding rates steady, allowing prices to hold their nominal levels and inflation to double earnings until the same result is achieved.

Any suggestions as to why this couldn’t happen? :unsure:

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Nope, it's called moneytization of the debt and is exactly what the US is doing to alleviate its Social Security and Trade Deficit obligations

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The media has a big part to play

The masses might not grasp the complex concept 'inflation' as effectively as a single figure like interest rates - it's too subtle - that's why GB/BOE are pursuing higher inflation - it's easier to hide

If they rose IR - EVERYBODY would take notice - meanwhile REAL inflation has reached 10+% without a big fuss - people are simply borrowing to bridge the gap between their virtually static wages and rising prices - without even realising it

Until the press makes the public more aware of inflation - IR won't move....

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No one else got any thoughts on this? Or is everyone resigned to inflation propping up house prices?? :(

How about this... that although the majority might like your solution a more economically significant minority would not. Therefore its a very high risk strategy for an independant central bank.

The minority being the business investor, the independant central bank being the BoE.

Putting aside the second assumtion and assuming that everyone agrees that that the BoE wont want to piss off the former, I now have to explain why runaway inflation would piss em off.

so here goes (follows very uninformed patchwork)

business investment takes place in a global economy, investment in a country gets wiped out by inflation, therefore inflation w/in a country is a disincentive to invest w/in it QED i think.

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Nope, it's called moneytization of the debt and is exactly what the US is doing to alleviate its Social Security and Trade Deficit obligations

Thankfully the BOE didnt sit back and let inflation drift this month, so hopefully my fears were unfounded :) . My further thoughts on this (copied from my latest post on the newsblog)-

But inflation will not prevent HPC, unless it really is runaway inflation, which I can't see the government being able to justify on any grounds.

If the ratio of house prices to earnings is to be restored to it’s long term average, a very long period of minimal house price increases and significant wage rises will be required. If prices struggle along on the flat then two important factors come into play – first the 'buy now or miss the boat' element disappears, which must undermine demand, which will further depress the market. Then the 'wait and see' effect steps in and you have a crash in the making.

Acceptable levels of inflation can't prevent this. House prices are currently about 6 times average wages. If wages continue to rise at 4%, then it will take 14 years to restore the ratio to 3 ½ :1. People will not continue to believe the hype for that long.

If we assume that the public can be duped for say 5 years, it would need 11% wage inflation and zero HPI for this period to restore the ratio. Does anyone really think that the BOE / government would tolerate this level of inflation without significant rises in interest rates?

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Thankfully the BOE didnt sit back and let inflation drift this month, so hopefully my fears were unfounded :) . My further thoughts on this (copied from my latest post on the newsblog)-

But inflation will not prevent HPC, unless it really is runaway inflation, which I can't see the government being able to justify on any grounds.

If the ratio of house prices to earnings is to be restored to it’s long term average, a very long period of minimal house price increases and significant wage rises will be required. If prices struggle along on the flat then two important factors come into play – first the 'buy now or miss the boat' element disappears, which must undermine demand, which will further depress the market. Then the 'wait and see' effect steps in and you have a crash in the making.

Acceptable levels of inflation can't prevent this. House prices are currently about 6 times average wages. If wages continue to rise at 4%, then it will take 14 years to restore the ratio to 3 ½ :1. People will not continue to believe the hype for that long.

If we assume that the public can be duped for say 5 years, it would need 11% wage inflation and zero HPI for this period to restore the ratio. Does anyone really think that the BOE / government would tolerate this level of inflation without significant rises in interest rates?

Don't forget that general real inflation is running near 10%+ as well - this is currently outstripping HPI - it's too far out of control already...

...and, yes, I think they'll let inflation rise (and adjust the CPI) if they can't control borrowing/spending by scaring people with the next couple of IR rises

They certainly won't raise IR levels to crash the housing market - that's for sure...

Wouldn't wage inflation also have to increase? If this happens then surely more offshoring of jobs will happen.

Nope, they've been surpressing wage inflation through immigration for years

In addition our taxes have gone up to pay for the increased stress on infrastructure (increasing general inflation) and BTL is thriving to house them all (increasing house price inflation)

They've been trying to dampen borrowing/spending by reducing wages but people have unconsiously been borrowing to bridge that widening gap between their wages and rising prices - the result - inflation

Your being shafted every which way and you never even notice - it's that subtle...

Edited by dnd

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But it needs wage inflation to restore the ratio. It makes little difference if price inflation alone rises. And it's much harder to disguise wage inflation, especially with so many now employed by the public sector.

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Interest rates are what would crash the housing market. Unfortunately the CPI cover-up is largely unreported in the mainstream media and so the markets seem content that a basis point this way and that represents the BOE controlling inflation. So we have negative real interests rates. A nice analogy is that of a car hurtling downhill, while the driver tries to slow down by easing the pressure on the throttle.

Joe public is fooled(forced?) into accepting wage increases lower than real inflation.

The end result, if BOE/FED are allowed to get away with this (they hope), is monetization of the national debts, renewed competiveness, and no apparent housing crash.

Who should we bet with? bull or bear?

Mark

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Joe public is fooled(forced?) into accepting wage increases lower than real inflation.

My point is that, unless wages rise dramatically to catch up with house prices (and the long term ratio of 3.5:1, average house:wages), we are faced with stagnation of the market, once people realise that they can't afford to move on. FTB’s who can't afford to get on the bottom of the ‘ladder’ never would, so people wont move up the ‘ladder’ and the whole thing grinds to a halt. Only then is sanity is restored, people stop saying ‘prices are too high but they wont fall’ and prices return to a realistic level. And all this without rates rising.

So low wage rises will not help ‘monetization’.

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Hi Bidin'matime

I hate to use a bulls argument, but we are talking relaxed lending criteria and BTL now. Part of the smoke and mirrors of low interest rates are pitiful annuity rates for pensions. Money is being introduced to the system. This is indeed one definition of inflation. BTL investors, foreign investors (sold mine to an Irsh one), city bonuses ...

My own feelings lie towards your own. I am now "out" of the "UK market" (moving to Sicily, waiting to re-enter down the line). I hope that those who wish to live in their property win out. However I fear it is not cut-and-dried, and there are powerful forces at work. Though the hidden inflation scenario seems far-fetched, I don't think it can be dismissed out of hand.

Mark

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This is a quite fascinating thread. I have to agree with Seismic Mark in that I think the CPI inflation cover up is a bit far fetched. Of course all goverments want to paint a rosie picture of themselves and their social and economic achievements and we all know NL are the masters of media control and spin. Gordon certainly isn't going to overstate inflation, but heck: show me a chancellor who will?

Albeit as a would-be-FTB, I would not like to see the UK enter into a 'housing market crash' led recession caused by high interest rates- recessions are bad, people loose jobs, public services suffer, repossesions rise, suicides rates rise. Who in their right mind wants that?

I grew up in 80's, I remember how crap it was under Thatchers rule: honest and hardworking parents struggling to make ends meet with double digit interest rates, one book between three in the classroom at school. No thanks!

Sorry, I digress - as I said this is a fascinating thread with many well presented arguments.

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Though the hidden inflation scenario seems far-fetched, I don't think it can be dismissed out of hand.

Real inflation rate is individual - it's different for everyone

Your's might be low - others might be high - you only have yourself and those around you as a reference (as do I)

One thing is for certain - it's subtle and it's being manipulated....

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I still come back to the point that, in order for people to start being able to afford to buy houses again, they must see their wages rise. Their perception of general inflation is neither here nor there – what matters is whether they perceive their wages to be rising faster than house prices.

My view is that the market will hit a wall once all those who can afford to buy / move up have done so. Without interest rates falling further, which seems highly unlikely, affordability falls as house prices rise faster than wages. Historically, people have traded up once the real value of their existing mortgage has dwindled with inflation and their higher wages now enable them to borrow more. However, having over-stretched themselves to get where they are (those who moved in the last few years), without rampant wage inflation, they will now be unable to move again for some considerable time. Therefore, stagnation.

The BTL brigade are a slightly different case, but they will have to stop buying at some point, presumably once the ‘subsidy’ that they are paying (ie the excess of interest and other costs over rental income) starts to get them wondering if it’s such a good idea after all.

Either way, we get stagnation. The only way forward is to have wages rise faster than house prices. But if house prices rise more slowly than wages for any length of time, this will (or should..) further undermine the logic behind BTL and will also encourage others that they no longer have to bust a gut to get on the property ladder or move up.

Take away these buying pressures on the property market and what do you get - falling prices. These encourage people to stand even further back and, before long, you have HPC.

In the meantime, the government tries to monetize its debt – money supply up 13% or so in the last 12 months. Faster money growth than output growth = inflation. Maybe people will see the benefit of this inflation in their pay packets before it shows in CPI and forces the BoE to raise interest rates further, but my feeling remains that it cannot close the gap between earnings and house prices fast enough to prevent stagnation, without such rapid inflation as to force the BoE’s hand and the raising of rates to levels that would themselves bring about HPI.

But I’m open to challenge on this, as it is starting to look like the only argument in town for HPC…

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Either way, we get stagnation. The only way forward is to have wages rise faster than house prices. But if house prices rise more slowly than wages for any length of time, this will (or should..) further undermine the logic behind BTL and will also encourage others that they no longer have to bust a gut to get on the property ladder or move up.

Don't want to play devils advocate Bidin' because in the main I follow your arguments but if wage inflation rises faster than house prices then slowly but surely housing becomes "more" affordable again and without fail the spin machine will go into overdrive telling FTB that now is the time to buy and some of course will, which will then free-up the 2nd and 3rd time buyer to move up the chain because the next rung has become more affordable for them too. My take on the housing market for at least the next 12 months is broadly stagnation with small "mini crashes" in some areas which will last at best a quarter before returning to stagnation. As you know we differ regarding HPC in that I believe the market will not crash under its own weight but will require a large shock of a bunch of simultaneous smaller shocks, without this I believe stagnation will prevail until such time as a better ratio of house prices to income returns.

Two real unknowns which I can't quite get my head around is; 1) How bad is the level of debt within the UK and how many rate rises will it take to break the camels back? 2) To what extent is immigration adding as a counter-balance to supply and demand of property and helping to hold up prices.

As to the first point if interest rates rise to 6% we will see some serious fall-out. As to the immigration argument I'm not sure but speaking to EA's I know in the West Country state that a lack of supply after 2-3 quarters of good sales is logically putting upward pressure on prices but they admit that considering lack of supply they have to be very careful on pricing to get the sale and the market is not awash with buyers with pots of cash, which looks again like stagnation.

Returning to the original argument regarding changing the inflation targets with my limited knowledge of such matters I don't believe even this government would be that blinkered and short-termist to allow higher inflation to rebalance the economy. Short term it could be a get out of jail free card but the long term effects of that type of policy would really hammer the UK competitiveness on an international stage and would crucify the new economic model of low inflation.

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Thanks Denzil.

I think there are basically three factors driving HPI: low interest rates, lax lending and the general belief that prices will continue to rise. A possible fourth is the more tangible demand factors such as migration, divorce and the formation of more households, but I agree that it is difficult to judge the impact of these – I’m not so sure that the true demand for housing really is greater than the expansion of supply.

What seems certain, however, is that these factors are all interrelated and will move together. As rates rise, lenders will become more cautious and price rises slow, possibly to a stop. The perception of runaway HPI recedes and the pressure to buy with it.

The impact on the other demand factors is more subtle, but my belief is that people choose to ‘form new households’ because of the other factors – if they can't afford to live independently, they simply don’t. I have known married couples who remain living under the same roof because neither can afford to live independently and I know people who have moved in together for primarily financial reasons when they might have remained living independently had they been able to afford it.

The same applies to offspring – if they are motivated to move out (by the other factors) then they will do so and ‘form a new household’, but if the other factors do not push them in that direction, they will remain at home. Then if they have moved out and costs rise (maybe the landlord puts up the rent in response to rising interest rates or maybe they have to sell there flat as they can no longer afford the mortgage), they may well return home, thus reversing the trend (I know this from my own offspring..). Or be motivated to move in with girlfriend / boyfriend.

So where does this lead us? I suppose it’s to my view that stagnation will lead to an effect equivalent to the ‘bunch of simultaneous smaller shocks’ to which you refer. I think we are agreed that, for HPC to be averted, house prices must remain in the doldrums for a considerable time – it’s the analysis of what happens then that seems central to the question as to whether it really is possible for HPC to be averted.

Thanks for your input - I’m off away for a week and a bit, so will pick up on this again when I’m back.

Edited by Bidin'matime

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  • 301 Brexit, House prices and Summer 2020

    1. 1. Including the effects Brexit, where do you think average UK house prices will be relative to now in June 2020?


      • down 5% +
      • down 2.5%
      • Even
      • up 2.5%
      • up 5%



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