Previous posts have assessed house price valuation using the national rental yield, defined as the sum of actual and imputed owner-occupier rents in the national accounts divided by the value of the housing stock. This measure has signalled house price undervaluation in recent years, contrary to the consensus view. This remained true in the first quarter: the yield stood at 4.48% versus an average since 1965 of 4.26%, suggesting that the average house price is 5% cheap relative to rents – see first chart.

The Office for National Statistics (ONS), however, revised its rents data earlier this year and plans to make further methodological changes in the 2014 and 2015 Blue Books. The 2014 revision, to be published at end-September, should lower recorded rental growth over 2010-11, resulting in a reduction in the rental yield from 2010 onward. The revised yield series should still indicate house price undervaluation over 2011-13 but on a much smaller scale. Current prices will probably be slightly above fair value on the new basis.

The ONS historically has based its estimates of rental inflation on a survey of household living costs. It plans to switch to a new methodology using data from the Valuation Office Agency (VOA), an arm of HMRC, in the 2015 Blue Book. The VOA is already used as a source for the actual and imputed rent components of the CPIH consumer prices index. Pending the 2015 revision, the ONS is aligning estimates of rental inflation since 2010 with the CPIH components. This change is being implemented in stages, with the final stage occurring in September.

The estimated impact of the September 2014 revision on the historical rental yield path is shown in the second chart. On the new basis, the yield may peak at 4.34% in the first quarter of 2012 versus a long-run average of 4.24%, implying house price undervaluation of 2% at that date – down from 9% on the previous basis.

The revised rental yield is estimated to have fallen to 4.13% by the first quarter of 2014, suggesting 3% overvaluation. This compares with peak overvaluation of 27% in the third quarter of 2007. So prices are now slightly expensive but still far from bubble territory.

The ONS changes may be questioned. The living cost survey data, showing faster rental inflation, could be combined with the VOA information, rather than discarded. Sceptics will note that ONS methodological “improvements” rarely raise inflation estimates. The changes will affect the GDP deflator and current-price GDP, so may have a small influence on the monetary policy debate.