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Cooling or crashing ?

Cooling or crashing ?. Professor Andrew Clare Cass Business School and consultant economist to LGIM. Overview. Have we ever had it this good ? Where are we now ? MPC: A stitch in time saves nine Is the slowdown for real this time ? Impact on the wider economy Conclusions. 12.00%.

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Cooling or crashing ?

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  1. Cooling or crashing ? Professor Andrew Clare Cass Business School and consultant economist to LGIM

  2. Overview • Have we ever had it this good ? • Where are we now ? • MPC: A stitch in time saves nine • Is the slowdown for real this time ? • Impact on the wider economy • Conclusions

  3. 12.00% 12.00% 10.00% 10.00% 8.00% 8.00% 6.00% 6.00% 4.00% 4.00% YOY change in UK GDP, % YOY change in UK GDP, % 2.00% 2.00% 0.00% 0.00% 1970 1974 1978 1982 1986 1990 1994 1998 2002 -2.00% -2.00% -4.00% -4.00% -6.00% -6.00% GDP growth – what a performance An unprecedented expansion Source: LGIM Research The longest period of sustained growth for decades

  4. 30.0% 30.0% RPI RPIX HICP 25.0% 25.0% 20.0% 20.0% 15.0% 15.0% Yoy UK inflation, % Yoy UK inflation, % 10.0% 10.0% 5.0% 5.0% 0.0% 0.0% 1970 1974 1978 1982 1986 1990 1994 1998 2002 … with low and stable inflation too ! Very low inflation Source: LGIM Research High stable growth, with low inflation as well – too good to be true ?

  5. Where are we now ? • Growth has been strong • Inflation is still low • We avoided the last global recession by borrowing

  6. Debt levels have soared Source: LGIM Research Secured and unsecured debt levels are both at record highs

  7. Paying it back … Source: LGIM Research Hands up if you have an interest only mortgage !

  8. Re-mortgaging: it’s been all the rage Further rate cuts Rate cuts Source: LGIM Research Rate cuts were directly responsible for this MEW “splurge”

  9. The consequence of all this borrowing Source: Datastream The average house price hasincreased by 300% since 1996

  10. 5.5 5.5 5.0 5.0 4.5 4.5 4.0 4.0 UK House prices to earnings ratio UK House prices to earnings ratio 3.5 3.5 3.0 3.0 2.5 2.5 2.0 2.0 1974 1976 1978 1980 1982 1984 1986 1988 1990 1992 1994 1996 1998 2000 2002 2004 Property prices now look ‘stretched’ How high can it go ? Source: LGIM Research The long-run average for this ratio is 3.5

  11. The house price to earnings ratio • For the ratio to return to a value of 4.0: • 6.5 years of 5% earnings growth if house prices were unchanged in the meantime, or • house prices to fall by 25%, or • some combination of the two !!! • Parallels with the NASDAQ in 2000 ?

  12. The MPC: A stitch in time saves nine • For some time the MPC has tried to play down talk of a “house price bubble” • But recently Governor Mervyn King said: “anyone entering or moving within the housing market should consider carefully the possible future paths of both house prices and interest rates” • So why are they putting up rates ?

  13. 8.0 8.0 7.0 7.0 6.0 6.0 5.0 5.0 MPC's base rate, % MPC's base rate, % 4.0 4.0 3.0 3.0 2.0 2.0 1997 1998 1999 2000 2001 2002 2003 2004 The MPC’s policy rate Rates still rising Source: LGIM Research, Datastream One more rate rise this year still a possibility

  14. Is the slowdown for real this time ? • Number of indicators suggest that the market is slowing • Been here before in 2003 • This time rates are going up • Evidence of the slowdown …

  15. Surveyors are pessimistic … again Source: RICS, Datastream But this time expectations are being influenced by interest rate hikes

  16. Mortgage approvals have fallen sharply Source: Datastream Mortgage approvals: an excellent lead indicator of future housing activity

  17. First-time buyers are thin on the ground Source: CML Maybe they’ll heed the Governor’s warning ?

  18. The impact upon the wider economy • Growth in 2005 will be lower • Service/private sector unemployment may rise • But we’re not headed for a re-run of the late 1980s • Financial market consequences (other things equal): • bond prices to find some support • equity market to struggle • sterling to come under pressure

  19. Conclusions • There is no doubt that: • house prices a very high • we are very indebted • this is all unsustainable • a slowdown will affect the whole economy • But there is still doubt about the: • scale of the correction • wider economic and financial market consequences

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