Mixed blessings: low consumer inflation alongside rising house prices spells trouble

Figures released by the Office for National Statistics (ONS) this morning show that Consumer Price Index (CPI) inflation fell to just 0.5% in the 12 months to December 2014, the lowest rate since May 2000.

Meanwhile, house prices, which are not included in the CPI index, increased by 10.0% in the 12 months to November. To many, this combination of statistics will sound like unadulterated good news: the goods we consume on a daily basis are getting cheaper, and the value of our homes is rising. For the two-thirds (65.3%) of people in the UK who own their homes, things are looking up. But this optimistic view hides the darker side of low consumer inflation and high house price growth.

Consumer inflation is one factor which feeds into wage offers – producers facing downwards pressure on the prices of their goods struggle to find extra cash to increase salaries. Meanwhile, productivity growth remains subdued and is expected to stay that way in 2015. This combination leaves employers with little incentive to boost wages. Although low CPI inflation means wages will go further when buying day-to-day items, the growth will not be anything like the trend rate of house prices. The CPI statistics don’t show you how those caught out of the housing market are falling further behind. In short, low consumer inflation combined with low productivity growth and relatively high house price inflation is a recipe for growing inequality of wealth.

The type of low consumer inflation the UK is experiencing at present isn’t a big cause for concern. Most of the reduction in prices observed is being imported through lower commodity prices, or through strong competition between supermarkets; that’s no bad thing. And unlike in the Eurozone, domestic demand remains relatively robust, indicated by strong growth in consumer lending. High house price growth, on the other hand, is a symptom of a mismatch between demand and supply. We’ve known for years that UK housebuilding is failing to keep pace with the rising number of households. When an asset is in short supply, its price naturally rises. In a free market, you would expect supply of the good to increase to take advantage of this. But tight planning regulations limit the increase of supply in the UK, preventing the market from adjusting.

Overcoming NIMBYism and dramatically increasing housing supply is a tall order, as Tom del Cassa explains. Essentially, the problem stems from fact that housing has two uses: as a service, accommodation, and as an investment good. Consumer polling carried out in October 2014 for our report Savings in the Balance found that 37% of GB adults would rather pay down their mortgage or invest in property than put money in a savings account or investment fund. Many see mortgage payments as a form of investment, rather than a payment for housing services. This distorts the housing market, creating demand for buy-to-let properties and diverting cash which could be put to more productive use elsewhere in the economy. Two relatively smaller policy changes could help to overcome this.

Firstly, the UK should adopt a headline measure of inflation which includes owner-occupier housing costs, CPIH, as Paul Johnson argued in his recent review, to provide a more balanced picture of the impact of rising house prices on consumers. Rising house prices mean that the cost of consuming housing services – keeping a roof over your head – is increasing. But for owner-occupiers, who move infrequently, the increase in the price of accommodation is obscured. Property price rises are more salient to owner-occupiers as appreciation in the value of their assets. Renters, however, who tend to move more frequently, feel the full force of these price rises in the costs of consumption. Adjusting the UK’s headline inflation measure to include housing could help to raise awareness of the effect of rising house prices on consumption and provide a more balanced insight into the consequences of higher property prices.

A second measure aimed at redressing the balance between perception of housing as an investment good and as a service would be to tighten the net on buy-to-let investors. Tax relief on mortgage interest on buy-to-let properties should be removed, with incentives instead focused on more productive investments. Stricter regulation of landlords would also reinforce the message that they are providers of housing services, not just investors. Strengthening the rights of renters where properties are in poor condition, for example, would make it clear that they are consumers who must be offered a reasonable level of service.

Together these changes could help to reduce our collective obsession with property investment. Ultimately, however, only when supply keeps pace with growing demand will the UK’s property market really begin to function


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