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ONE of the most interesting questions at the moment therefore US House prices back, what looks like fair value have corrected, if prices in many European markets not. Quoted in today’s FT Martin Wolf Ben Broadbent (now on the monetary policy Committee) as a reference to low real interest rates as a reason for the continued strength of UK prices. This is bugging me for two reasons, a practical and a theoretical (that I will leave the maintenance until the end of the post for those).
Of course, the practical reason is that U.S. real interest rates to please. So why still was not US House prices driven by the same process? Before you give the answer too many houses built in the United States, you should be aware that the Spanish and Irish House prices either fallen again on fair value not yet, although both countries are filled with empty properties.
It occurred to me also, that measures the real interest rates, that taking official borrowing costs may be distorted (not least by QE). House – and homeowners can borrow not at the same prices as Governments. So the central measure of real interest rates is the cost of the mortgage financing minus the rate of growth of wages. This is shown prices in these two diagrams with the House index on a separate axis. As you can see in the United States the lowest level, real interest rates have plunged in the last quarter century, but it has not helped the housing market at all.
In fact, if you the data covered by 24 years and the average house price winning it in three, then share if real interest rates were high was bigger (for 2.25%) as if real interest rates were low (1.7%).
In the UK, however, seem low real interest rates have made a difference. You fell through the long boom, Spike (thanks to low wage growth) in 2009 and fell again. In the 15 years for which we have data, the third of the years in which saw highest were average price of 1.6% fall, while the third years on average saw where prices were lowest profits of 9.6%.
But this is rather unsatisfactory; Why should so much difference on one side of the Atlantic, but not on the other put real interest rates? There is more to do this next week, but let us turn to the theoretical problem.
Low real interest rates drive for the same reason, the low income bonds drive higher real estate prices up (say the experts). But let us about this on the simple (ish) example of a Inflationsindexierte bond. Take the subject of 2.5% of the UK Government 2024 (the numbers are here). The value of the bond runtime par are multiplied with the ratio between the index of the RPI eight months before output (97,7 in this case) and the same eight months before maturity. Currently the RPI 232,5 is market value of the bond by 235% of par. But it is 327% of par; in other words, the real yield has fallen and the price has risen. If the RPI not from here changes, a loss of capital will suffer investors. Or it otherwise, to rise again at the end of the term of in real capital market interest rates.
Now it can be many reasons for the purchase of bonds in such a low yield; in particular pension funds use, meet their liabilities and so are indifferent to price. But you can see that a return to the mean in the structure of the bond is built.
But what about real assets such as stocks and homes? The big argument at the end of the 1990s was that shares earned higher ratings because real interest rates were low. In theory, the current price of the discounted value of all future cash flows should be the same, then other things are equal, a decrease in should lead the discount rate to a price increase. But other things are not equal. Low real interest rates should propose low expectations for future growth. This is true, whether the (as today) low prices by central banks have developed, or whether it the result of supply and demand for savings. In the first case are central banks keep rates low because they are concerned about the rate of growth; If they are wrong then inflation arise quickly (and prices need to rise). In the second case would be low prices of the desired savings, which are higher than the desired investment; There are not enough simply exciting investment projects, go low growth which means.
As share prices correspond to the discounted future corporate cash flow should be, then the discounted value of the future rent real estate prices. Now for rent (income were very low) have recovered a little. But it’s certainly not plausible that rent quickly every year can rise in a low growth environment, because as tenants, they will make? In other words, the Bank of England has completely wrong monetary policy or UK House prices are still too high.
** Fair value assumes that say that, as in the United States or Germany, real estate prices in real terms in the long run not rise or she very slowly rise, 1% per year.
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