House prices: could they fall?

How likely is a slump in the UK housing market? Recent news tells us less than you might think.
First, the Times reports a 0.1% fall in Hometrack's house price index with:

House prices fell for the first time in two years this month, sending a shudder through millions of homeowners.

Not through me, it didn't. The oldest cliche in economic punditry is that you mustn't read much into one month's data. This is a cliche because it's true.
Over the last 10 years, Nationwide and HBOS's house price indices (which have longer track records than Hometrack's) have risen by a monthly average of 0.9%, with standard deviations of 0.8 and 1.4 percentage points respectively. This means that you'd expect the Nationwide to report a house price fall one month in seven, and HBOS to report a fall one month every five, even if prices are on a firm upward trend. A monthly fall, in itself, tells us nothing. What was that I was saying about news being noise?
But what about the news that mortgage approvals have hit a two-year low? Doesn't this point to falling prices?
Not yet. This chart shows that there is indeed a good correlation (0.72, R-squared = 52.2%) between mortgage approvals and annual changes in house prices (HBOS's measure)  in the following 12 months.
But the thing is that approvals, at 102,000, aren't yet low enough to point to falling prices. The post-1987 relationship says this points to prices rising 9.7% in the next 12 months (the standard error is 6.6 percentage points).
The belief that house prices will fall significantly, then, owes less to the news than to our Bayesian priors: the possibility that high ratios of prices to earnings are unsustainable; the prospect of tighter lending critera and lower City bonuses after the summer's financial crises, and so on.
Are these priors right? Well, put it this way - I hope to trade down soon. 

Comments

[Mark Wadsworth]

How likely is a slump in the UK housing market?

It's more or less 99% certain, according to the eighteen-year-cycle theory.

[Bruce]

Noise flash: Nationwide said today that UK house prices rose at their fastest rate in four months during October - by 1.1% from the previous month.

[raf]

As long as people can manage their interest costs and demand remains strong then prices cannot fall. Of course this assumes banks still have the ability to lend at their leisure on valuations supplied.

As Mark notes it is likely we are into the end phase of the 18 year cycle which started in 1992. The recent credit crunch was the early warning system.