On the "best" evidence (see below), the average UK house price is only 3% below the 2007-08 peak. The average home-owner, however, has experienced a decline of 11%. The difference is explained by the outperformance of expensive properties.
 
The wide range of house price measures showing divergent performance is a boon for biased commentators seeking evidence to support their particular thesis. The chart compares five widely-quoted measures, rebasing each to 100 at the 2007-08 peak*. All five claim to be constant-quality measures and have been adjusted for seasonal variation. (Four of the five providers publish seasonally-adjusted series; the DCLG index has been adjusted within Datastream.)
 
Bears, naturally, focus on the Halifax / HBOS index, which is down by 20% from a peak reached in August 2007 and fell by 4% in the year to May. At the opposite end of the range, the LSL Academetrics index is 3% below its February 2008 high and has risen by 1% over the last year.

The construction of the various indices differs in numerous respects but a key distinction is whether a particular gauge aims to measure changes in the average price of property or in the price of an average property. In the former case, price changes are combined using value weights, thereby assigning greater importance to more expensive properties. This is appropriate if the focus of interest is movements in the aggregate value of the existing housing stock. Volume weighting, by contrast, treats expensive and inexpensive properties identically, resulting in an index that measures the experience of the average home-owner. (In stock market terms, this is equivalent to the distinction between share price indices measuring performance using market capitalisation and equal weights.)
 
LSL Academetrics and DCLG use value weights (average property price) while the Land Registry (LR), HBOS and Nationwide use volume weights (average home-owner experience).
 
Other important differences include: 

• Sample representation: The DCLG, HBOS and Nationwide measures are based on mortgage transactions while the LR database – also used by LSL Academetrics – includes cash sales.

• Sample size: The LSL Academetrics index is based on the largest sample, followed by DCLG and LR. HBOS and Nationwide numbers vary with their share of the new mortgage market.

• Stage of purchase process: HBOS and Nationwide record prices on mortgage approval and DCLG on mortgage completion. The LR and LSL Acadametrics indices use prices registered with the Land Registry, implying a typical 2-3 month lag relative to HBOS / Nationwide.

• Quality adjustment: LSL Academetrics and DCLG base their indices on a constant mix of properties while HBOS and Nationwide use hedonic regressions to correct for quality difference. The LR index is based on repeat sales (like the US Case-Shiller index). These different methodologies should, in theory, produce similar results.

These considerations suggest that the LSL Academetrics index is the "best" value-weighted measure, since it is based on the largest sample and includes cash sales. The LR index is the preferred volume-weighted measure for the same reasons. The trade-off is that they are less timely than the HBOS and Nationwide indices.

As noted, the LSL Acadametrics index was 3% below peak in May. The alternative value-weighted measure, the DCLG index, was 5% lower in April (the latest available month). The difference may be explained by the former's inclusion of cash sales, assuming that these have been associated with stronger prices. The LSL Acadametrics measure rose by 1% in the year to May versus a flat performance of the DCLG index in the 12 months to April.

The LR index, measuring the experience of the average home-owner, is 11% below peak and fell by 1% in the year to April. Interestingly, this accords with the Nationwide measure – 11% below peak and down 1% in the year to May – but not the HBOS index – 20% and 4% respectively. The recent significant divergence of the HBOS index from other measures suggests that it should be given less weight in assessing market trends.

House prices remain elevated relative to incomes but not rents. A measure of the rental yield derived from the national accounts (i.e. the sum of actual and imputed rents divided by the value of the housing stock) is exactly in line with its average since the early 1960s – see second chart and previous post for more discussion.
 
Forced selling pushed house prices to an undervalued level relative to rents in the mid 1970s, early 1980s and early 1990s but is much less of a factor today, reflecting low interest rates and a stable labour market. Rents, moreover, are growing strongly as tenant demand outstrips supply, so an increase in the rental yield to above its long-run average could be achieved without any further fall in house prices.

*Other measures include the Rightmove and Hometrack indices, both based on surveys of estate agents. The Rightmove index uses asking rather than sale prices while the Hometrack measure is based on a relatively small sample size.



The OECD's leading indices are signalling a further slowdown in emerging-world growth, consistent with earlier and continuing monetary weakness.

The forecasting power of the raw indices can be enhanced by data transformation, resulting in an indicator with a longer lead time. For the "E7" economies (defined here as BRIC plus Korea, Mexico and Taiwan), this indicator is below a low reached in spring 2010 before a summer slowdown and suggests that six-month growth in industrial output will fall from 5.4% in April to about 2% by late 2011 – see first chart.

As previously discussed, six-month E7 output changes are closely correlated with industrial commodity price fluctuations (0.87 correlation coefficient over the last 15 years). Based on the historical relationship, a six-month output rise of 2% "forecasts" a 4% fall in commodity prices (as measured by the Journal of Commerce index, which includes energy).

Six-month growth in E7 real narrow money has continued to slow, suggesting a further decline in the leading indicator. Real money, unusually, is now growing faster in the G7 than the E7 – second chart. (The chart includes data up to April so excludes the further slowdown in Chinese real M1 in May – see yesterday's post.) The G7 monetary pick-up may offset E7 weakness, maintaining global economic expansion, albeit at a slower pace than in 2009-10.


On the consensus interpretation of May figures released today, the Chinese economy retains momentum while inflationary pressures are still rising, warranting a further tightening of monetary policy. The People's Bank, indeed, took the opportunity to announce a further 0.5 percentage point hike in reserve requirements, although this was probably required to sterilise the liquidity impact of continuing foreign reserves accumulation. Industrial output grew by an annual 13.3% in May while CPI inflation rose to 5.5%, the highest since July 2008.

The annual rate of change numbers, however, conceal a recent economic slowdown, consistent with earlier monetary weakness. Industrial output grew by an estimated 5.6% in the six months to May, down from 7.2% in the prior half-year – see first chart. Monetary trends, moreover, have deteriorated further, with real M1 rising by just 1.8% in the latest six months. A similar slowdown in real M1 in mid 2008 preceded a contraction in industrial output.

"True" inflation may be near a peak. Annual M1 growth topped in January 2010 and its maximum historical lead at highs has been 22 months, suggesting an inflation peak by November 2011 at the latest – second chart. The published CPI numbers, however, have been suppressed by price control measures and, possibly, statistical manipulation so could stay elevated for longer, even as underlying inflationary pressures begin to moderate.

The scale of cumulative monetary expansion in recent years coupled with a positive output gap suggest that the authorities must maintain restrictive conditions for a prolonged period for "true" inflation to return to an acceptable level. With monetary trends already signalling a bumpy economic landing later in 2011, however, the consensus recommendation of further policy tightening is questionable.

The broadest measure of the US money supply (derived from the quarterly Fed flow of funds accounts and comprising currency, checkable deposits, time deposits, savings deposits, foreign deposits, money market mutual funds and repurchase agreements held by households, non-financial businesses, insurance companies and pension funds) rose by 8.9% annualised during the first quarter – see first chart.

QE2 has been more effective in stimulating broad money expansion than QE1 because the Fed has bought a larger proportion of securities from the non-bank private sector. (Purchases from monetary institutions and foreign investors, by contrast, have no first-round impact on the money supply.) According to the flow of funds accounts, the Fed bought $1.39 trillion annualised of Treasuries during the first quarter while the household sector – including hedge funds – sold $1.14 trillion.

Part of the boost to household liquidity has been transferred to non-financial businesses via increased inflows to equity and corporate bond mutual funds. Non-financial business broad money rose by 7.5% in the year to the first quarter – the largest annual increase since the first quarter of 2008.

The pick-up in broad money confirms a positive signal from narrower aggregates, suggesting solid economic growth over the remainder of 2011. Monetary expansion could slow after QE2 ends but any impact on the economy would be delayed until early 2012. Improving credit trends, moreover, could compensate for the loss of Fed stimulus: banks' loans and leases expanded in May for the first time since October 2008, reflecting rapid growth of commercial and industrial lending – second chart.

Sunday Times economics editor David Smith argues for a government-directed expansion of bank lending to the corporate sector and house purchasers to accelerate economic recovery.  It is far from clear that such an initiative is necessary and it could prove counter-productive.

The financial surplus of private non-financial corporations (i.e. the excess of retained earnings over capital spending) was £22.9 billion or a record 6.2% of GDP in the fourth quarter of 2010 – see chart. Firms in aggregate have more than sufficient internal resources to fund expansion. A contraction in aggregate corporate bank borrowing is neither surprising nor concerning against this backdrop.

Some SMEs with good business prospects may be unable to access credit but there is little evidence that the problem is widespread or critical. In the CBI’s April survey of manufacturing SMEs, 9% of firms stated that capital spending plans were likely to be constrained by an inability to raise external finance compared with 54% citing uncertainty about demand as a negative factor. The 9% figure was just one percentage point higher than in the companion large-firm survey.

Government-mandated credit quotas risk forcing banks to lend to financially-weak companies with poor long-term prospects, raising the spectre of a Japan-style scenario in which “zombie” firms on official life support divert resources from more productive activities, slowing economic growth.

A forced increase in mortgage lending, meanwhile, would probably serve mainly to boost house prices rather than new construction or economic expansion.

Mr Smith’s claim that broad money growth of 1.5% is “inconsistent with sustained recovery” ignores the possibility that the velocity of circulation has embarked on a sustained upswing – it rose by 3.7% annualised between the second quarter of 2009 and the first quarter of 2011. When real interest rates were last heavily negative in the 1970s, velocity rose by a cumulative 38.6% over six years, or 5.6% annualised. Such a rate of increase, combined with 1.5% money growth, would support strong economic expansion and a continued inflation overshoot.