Weakening British Housing Market Will Weigh on the Pound

 | May 11, 2017 | 9:00 AM EDT
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The British pound has been into some sort of mini-recovery after the deep plunge it took following the Brexit vote last June. Sterling is approaching the $1.30 level for the first time since last September, when hopes were increasing that a "soft" Brexit, with the U.K. keeping access to the European Union's single market, would be possible.

But one piece of data out today suggests that the pound's mini-recovery is about to end. A closely watched monthly poll of property surveyors by the Royal Institution of Chartered Surveyors (RICS) showed that the housing market continued to weaken in April, with both sales and new buyer enquiries edging lower.

Because of tight supply, the price growth indicator remained unchanged from March, consistent with steadily rising house prices. But the overall indicator conceals wide variations. The reading for central London -- the favorite playground for foreign investors before the Brexit vote -- has been in negative territory for 13 consecutive months.

Expectations are also weak. An indicator for near-term price expectations softened to the lowest reading since July 2016, suggesting that surveyors anticipate a slowing of inflation in house prices for the three months ahead.

Foreign investors always have played an important role in the U.K. property market, but it looks like they are still enjoying the sidelines. The Brexit vote, coupled with conditions abroad -- among them a Chinese government crackdown on capital outflows and the low oil prices affecting potential buyers from the Middle East and Russia -- have slowed the flow of foreign money to a trickle.

Domestic buyers cannot pick up the baton as properties in central London are too expensive for ordinary Londoners. Banks threatening to move thousands of jobs abroad because of Brexit risk add to the problem, because selling by these highly paid workers potentially would increase the glut of high-end properties on the market.

The general election called by Prime Minister Theresa May for June 8 further complicates matters. The comments by surveyors in the RICS release are illustrative of the issues confronting the market. "General Election, Brexit, Trump," were the reasons for the sluggish market quoted by one surveyor. "The continued uncertainty in the economy with Brexit, the forthcoming election and the high rates of stamp duty continue to dampen activity in the market," said another.

The idea that sellers should cut asking prices is beginning to show up in surveyor comments. "Too many vendors over-pricing homes [are] stagnating the market with unrealistic expectations," said one, while another commented: "Too many vendors [are] seeking unrealistic figures."

And there is the rub. If sellers do decide to drop their prices, and if house prices continue to drop, the U.K. could be in for serious problems. Household wealth, and therefore consumers' confidence and their ability to borrow and spend, are closely tied to property prices in the U.K., perhaps much more than in the U.S., where more people invest in the stock market.

A slowdown in the housing market -- or worse, a crash -- would lead to a sharp decline in U.K. consumer spending, because it would exacerbate weakness that already has been caused by rising inflation and uncertainty over Brexit.

Therefore, expect the Bank of England to keep interest rates low for a prolonged period of time or even to restart its asset purchases if house prices decline for too long.

The government also could increase its stimulus programs for the housing market. Already, it is offering equity loans to buyers valued at 20% of a property's price outside London and 40% in London itself. This stimulus has been boosting homebuilders' profits and has acted as an important prop for demand from people who otherwise would not be able to put together a deposit for a home.

The flip side of the housing market stimulus coin will be a weaker pound. Negative real interest rates will push investors out of the pound if the Fed continues to increase its own rates and if the situation in the eurozone keeps improving and the euro strengthens.

Besides, the additional government borrowing that will be necessary to sustain house price subsidies if the market continues to weaken will put even more pressure on government bond prices. The pound's rebound will be short-lived.

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