Should you buy a property to protect against inflation?
By
MoneyWeek Editor
John Stepek Dec 21, 2010
Print this article
People are starting to get worried about inflation.
Consumer price index (CPI) inflation – the official measure – is sitting at 3.3%. But the most recent survey from the Bank of England showed that people believe inflation is more like 3.9%. And they reckon it will stay at that level for the next 12 months.
That's the highest expectations have been since 2008. In February, consumers thought inflation would be just 2.5% over the next 12 months. The big danger with expectations is that they may become reality, as people demand higher wages to match, and companies push up prices as a result.
So are we going to see interest rates rising soon? The Confederation of British Industry (CBI) reckons so. In fact, the CBI reckons that the Bank will start hiking rates within the next six months. But are they right? And if inflation is set to head higher, how best can you protect yourself?
The Bank of England has given up on inflation
The Bank of England just doesn't seem interested in the level of the Consumer Price Index anymore. It's been well above the target rate of 2% for the whole of this year. Only one Monetary Policy Committee member is calling for higher interest rates – Andrew Sentance – and he's been widely criticised because of it.
This has led some pundits to suggest that the Bank may no longer really be targeting CPI. Jim Leaviss of M&G reckons that the Bank of England has "moved away from pure-inflation targeting to more of a 'dual-mandate'." In other words, it worries about the economy as a whole, rather than simple price stability.
To be fair, the Bank can easily make the argument that it is still trying to hit its target. After all, if interest rates rise by much – perhaps at all – then anyone with a home loan is going to feel the pinch. That would cut into consumer spending, which would ultimately be deflationary.
That is, assuming that wages don't rise to match. And as my colleague Merryn Somerset Webb pointed out on her blog last week, this is the indicator that you really have to watch. What happens to CPI will be of secondary importance to the bank over the next year. Mervyn King and his colleagues will be much more worried about wages.
For as long as consumers feel that they need to absorb any rises in their cost of living, rather than pass it on to their employer, there won't be a threat of a wage-price spiral. But as soon as people start to demand higher wages, and employers feel forced to pay them, then you run the risk of over-heating.
The housing market is still not looking healthy
The other area of the economy that the Bank will be watching of course, is the housing market. And that's not looking too healthy. Gross lending to buy residential properties came in at £11.1bn in November. That was down 5% on October, and 10% year-on-year. This is shaping up to be the worst second half for home loans since 2000, according to the Council of Mortgage Lenders (CML).
In estate agent speak, the figures apparently reinforce the impression of a 'flat market'. It seems that a market where prices are falling at anything less than a double-digit rate is a 'flat market'.
Meanwhile, approvals for loans to buy new houses remain hovering around the 45,000 mark. You can get more details and charts on the general state of the housing market here. But in historical terms, this is a pretty low number, and it's been around that level for most of this year.
And next year, net lending (ie the amount of money dished out minus the amount paid back by householders) is expected to come in at £6bn. That's even less than we saw this year, and compares to a peak of £110bn in 2006, when there was plenty of 'equity withdrawal' as people used their homes as cash machines.
So there's no sign that the market will pick up any time soon – quite the reverse, in fact.
Isn't property a decent hedge against inflation?
But if inflation is set to rise, then shouldn't you be buying a property? Preferably as soon as possible? After all, inflation is good for 'real' assets. And property has acted as a decent inflation hedge over the very long term, according to figures from Capital Economics. Since 1970, if you'd bought and held the average house for 20 years before selling, then your real capital growth would "always have been positive", apart from the 20-year period ending in 1993/94.
Over five- and ten-year periods, it becomes less of a sure thing. But property investors by and large always say they're in it for "the long term". So is now a good time to buy?
Probably not, reckons Paul Diggle of Capital Economics. The trouble is that house prices just now are starting from a point where they are rather over-valued. If you ignore the house price boom of the early-to-mid 2000s as being primarily the result of a credit-induced bubble, then the long-term real growth rate (ie after inflation) of house prices comes in at around 2.25% a year. On that basis, says Diggle, real house prices "look to be something like 20% too high relative to trend."
This also leaves prices very vulnerable if the Bank does feel forced to raise rates due to rising inflation. And then there's the threat of any further rise in unemployment due to public spending cuts. Factoring all that in, the risk / reward outlook is pretty unappealing. "Residential property is currently a poor prospect for those looking for decent real terms capital gains over anything less than the very long run," says Diggle.
If it's some sort of inflation protection you're after, we'd be more inclined to stick with the stalwarts of high-yielding blue chips and gold. And you can learn what our Roundtable experts think about the inflation / deflation debate in the Christmas issue of MoneyWeek magazine, which comes out a day early this week, on Thursday rather than Friday. If you're not already a subscriber, get your first three copies free here.
Our recommended article for today
Latest figures show that the UK's manufacturing sector is bouncing back from recession faster than anticipated. Here, Tom Bulford picks one small-cap firm that took a battering, but which is now staging a recovery.
Published in
Property
| More
articles
by
John Stepek
Related articles
-
By Matthew Partridge, May 24, 2012
-
By Merryn Somerset Webb, May 22, 2012
-
By Merryn Somerset Webb, May 21, 2012
-
By Merryn Somerset Webb, May 21, 2012