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Edmund Conway, Nouveau Bear, Speaks Out Again...


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Overvalued house prices threaten crash

By Edmund Conway, Economics Editor

Last Updated: 2:25am GMT 02/01/2007

House prices are at their most overvalued for 15 years, new figures showed yesterday, as hard-pressed home-owners struggle to pay their mortgages.

And with the gloomy prospect of a record tax burden and unprecedented rises in household bills comes a warning that interest rates could rise by far more than expected.

Morgan Stanley and PriceWaterhouseCoopers warn there is a high chance of a severe fall in house prices in the coming years

A study commissioned by The Daily Telegraph shows that house prices are moving well beyond the reach of many families as the rapid growth in property values outpaces increases in incomes.

The Daily Telegraph/Lombard Street Research Housing Affordability Index shows that they are more overvalued than at any time since 1991 — when prices were plunging after the last major slide.

Affordability has fallen by three per cent in the past nine months, and almost a fifth in only four years.

The affordability barometer, in which 100 points represents the average expense of house prices since the early 1960s, is now at 94.3 points.

advertisementHouses become less affordable when prices rise faster than earnings. A rise in interest rates also makes life more difficult and all of these factors are taken into account in the research.

The figures coincide with a warning from one of the country's leading economics experts that interest rates could rise by more than one per cent to more than six per cent within 18 months.

This comes days after statistics showed that the average homebuyer is borrowing 6.5 times their salary when taking on a new property.

The investment bank Morgan Stanley and the consultants PriceWaterhouseCoopers warned that there is a high chance of a severe fall in house prices in the coming years.

Prices rose sharply over the past decade, sparking fears that, when families realise they cannot afford to a new home, the market could be badly hit, with knock-on consequences for the rest of the economy.

But many first-time buyers, whose numbers are already at record lows, will still be prevented from taking their first step on to the housing ladder this year, since prices are unlikely to stop rising in the near future, Lombard Street Research (LSR) warned. The analysts were the only major forecaster to predict correctly rapid house price inflation of almost 10 per cent in 2006.

An LSR economist, Diana Choyleva, said she thought prices could rise by as much as 15 per cent in 2007. But she warned that if the Bank of England did not prevent people taking on excessive debt by raising interest rates, it risked laying the foundations of another major collapse.

"The Bank could risk finally spawning a house price bubble in 2008," she said.

"Our affordability indicator extended its fall in the third quarter of 2006 and is likely to have declined further in the fourth quarter."

Mervyn King, the Bank's governor, said last May: "Relative to average earnings or incomes, or anything else you could look at, house prices do seem remarkably high."

Since then, prices have risen further still, making it likely that the Bank will be wary of encouraging people to take on more debt.

Prof David Smith of the University of Derby, the chairman of the "shadow" monetary policy committee, has predicted that — far from falling later this year as many City experts think — borrowing rates could rise from their present level of five per cent to reach 6.25 per cent midway through 2008.

The prediction will come as a blow for households, many of whom are already struggling to meet their monthly mortgage payments and other bills.

Prof Smith said he feared the Bank would take this decisive action to take control of the burgeoning level of personal debt, which has now passed £1,300 billion.

This, and the likelihood that the pound could fall against other currencies, could force it to raise interest rates.

"The MPC [Monetary Policy Committee] will be batting on a very sticky wicket over the next few years," said Prof Smith. "Rates are expected to end 2007 at 5.75 per cent, and rise to 6-6.25 per cent in 2008."

He said that the Bank had left interest rates at too low a level for too long and would soon have to face the consequences.

He predicted another year of rising house prices, but warned that as borrowing costs become too great for many families, the market will slow dramatically, before going into reverse in 2009.

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