Mr Bean, QE and US house prices

Mr Bean doesn’t say much publicly, so the bond market spent last week pouncing on every utterance of his UK tour (usually without much regard for the context in which things were said) in an effort to answer the key question of whether or not the Bank of England would continue its program of Quantitative Easing.

Yesterday morning we got a few more clues after the minutes of the last Monetary Policy Committee meeting were released.    As could be seen from the gilt market’s reaction (10 year gilt yields at one point almost reached 3.9%, the highest for a month), the interpretation wasn’t too gilt-friendly.  Some of the key messages in the MPC minutes were that although monetary data is not providing a precise guide to the success of QE, broad money growth has picked up sharply.  Inflation has been surprisingly high over a number of months.  Labour markets are weak and wage growth is expected to weaken further, but employment had come in higher and unemployment lower than expected.   The more forward-looking surveys suggest growth and inflation (in the short term) may be higher than previously expected.  So possibly it is actually the beginning of the end of QE, rather than the end of the beginning.

Another important point in the minutes was the reminder that “one risk to the economic recovery in the US and possibly the world was the US housing market”.  That’s because house prices affect people’s collateral, thus affecting their ability to borrow.  House prices affect banks’ assets (and therefore also affect the banks’ ability to lend),  And house prices affect the amount of residential investment.

We’ve recognised the importance of the US housing market, and have written extensively about the health of the market on this blog.  It was the fall in US house prices that began in the second half of 2006 that sparked the chain reaction leading to this financial crisis.  Presumably, it will be a recovery in house prices that will help to bring us out of this financial crisis (and we’re definitely still in one, as CIT’s woes demonstrate).

US house prices are sharply lower than a year ago, as this chart shows.  According to the S&P/Case-Shiller indices, house prices fell 18.1% in the year to April (May’s numbers come out next week), albeit the pace of decline seems to be slowing, with April 2009 seeing the smallest fall since June 2008.  House price data from  two other sources, the National Association of Realtors and the Federal Housing Finance Agency, had US house prices rising in May.

However it’s difficult to see a sustained rise in US house prices, or indeed a buoyant economy, until the overhang of unsold stock on the housing market (or ‘inventory’) begins to clear.  A good measure of the inventory overhang is ‘months supply’ , which says how long it will take to clear the supply overhang at the current level of demand.   The measure is a good predictor of US recessions (see blog from Feb 2008 here) and isn’t a bad predictor of growth either.  Inventory levels have improved in recent months, but at 10.2 months supply, there is still a significant inventory overhang.  This has much to do with delinquencies (now 25% for subprime, or 9.1% in total, which is the highest since records began in 1979), unemployment (already highest since 1983 and still rising) and rising repossessions.  History suggests that months supply will need to fall to about 7 months supply before we see a sustained recovery in both the economy and the housing market.

Discuss Article

  1. longodds says:

    My own " on the ground " research tells me that unemployment in the UK is set to go a lot higher, so if consumer spending based on an improvement in confidence, is what the markets are anticipating I think they are going to be disappointed.

    Small businesses are hurting badly. For example I was in one, a cafeteria, which I would have expected to be weathering the storm well given that the quality is relatively high and the prices relatively low.  The owner told me business was grim and there has been no hint of recovery at all since turnover fell off a cliff late last year.

    Her husband who was an IT professional had just been made redundant and she was talking about  training ie her not her husband as a motor mechanic or plumber.

    I have seen little or nothing at basic ground level to indicate any sustainable recovery is underway but for the sake of hard working young people like this lady I hope I am wrong.  

    Posted on: 23/07/09 | 12:00 am
  2. Anonymous says:

    Howdy. Any chance of some comment on QE exit strategy? Bean said to the Nottingham Evening post that they would be likely to raise interest rates before selling back their gilts. Why would they do it in that order? He made the comment that they'd sell the gilts at rates that reflected market circumstances at the time, but if they raise interest rates first, aren't they likely to front run themselves and end up realising a worse price for the gilts?

    Yours confusedly

    Posted on: 24/07/09 | 12:00 am
  3. Anonymous says:

    US Housing – the actual amount of new housing supply is tiny and at its lowest ever relative to the total housing stock. Any reasonable pick up in sales will very quickly blow the 10.2 months away. This is not a good indicator at this stage of the cycle as you will be surprised by the speed of the move and you must take into account  just how low the actual numbers are. 10.2 months supply currently = 292k. Back in Feb88 9.9 months = 478k.

    Posted on: 27/07/09 | 12:00 am
  4. Michael Riddell says:

    Apologies, when I said a good measure of the inventory overhang is 'months supply', I meant to say that a good measure of the demand-supply imbalance is the months supply. As you correctly point out, the amount of unsold stock has been much higher in the past. I don't think this makes the measure irrelevant though – supply is low, but if demand is lower, then prices fall. 

    Posted on: 31/07/09 | 12:00 am

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