Too much hinges on house prices: but Britain may yet avoid a crash

Housing in London, where the property market has slowed down because prices were too high for anyone to afford. Photograph: Dan Kitwood/Getty

House price crashes are rare in Britain and it’s not hard to see why. This is a small country with tough planning laws and a tax system that creates incentives for people to invest in bricks and mortar. Mostly, limits on supply plus strong demand equals rising prices.

There is little to suggest that the property market is about to go though the agonies of the late 1980s and early 1990s, when prices fell in real terms for more than half a decade and record numbers of homes were repossessed.

But the market has weakened since the start of the year and will remain weak for the foreseeable future. And that will have consequences for the wider economy. There are a number of reasons for the slowdown. The buy-to-let sector has gone cold since more a more stringent tax regime was introduced last year. Households have seen their real incomes squeezed by rising inflation and this has made them risk-averse on big financial decisions.

A flat period was also inevitable in those parts of the country – primarily, but not exclusively, London – where the market was running hot in the middle years of the current decade. House prices rose so high that buyers simply couldn’t afford them.

Even so, the market is more likely to suffer a prolonged period in the doldrums rather than a full-blown crash. The extremely difficult period in the late 80s and early 90s was caused by a doubling of interest rates from 7.5% to 15%, which in turn led unemployment to rise to more than three million. The current backdrop could hardly be more different: the unemployment rate has just fallen to its lowest level in four decades while rates are at 0.25%. Mortgage arrears are historically low.

Clearly, the picture would change if higher interest rates plunged the economy into recession. That would result in higher unemployment and higher arrears, and turn house prices negative. The Bank of England is wary of tightening policy for that very reason.

As Kallum Pickering of Berenberg has noted, there is a close correlation between house prices and consumer spending: a 10% year-on-year increase in house prices normally implies a 2.5% increase in spending. Conversely, falling house prices would have a negative impact on spending patterns, particularly given households’ high level of debt.

As the first six months of 2017 have shown, when the housing market is weak, consumer spending is weak. And when consumer spending is weak, the economy doesn’t grow very fast. The weaknesses of this economic model are glaringly apparent.