RICS Survey Points to More U.K. Housing Sector Weakness

The survey of housing market conditions in the U.K. continues to show strength in prices versus weakness in activity. Housing price expectations, however, were reduced on the month as new sales continued to post weaker results and sales prospects fell sharpy to a weak level. The residential survey from the Royal Institute of Chartered Surveyors (RICS) demonstrates the growing malaise and also the mixed set of conditions in the U.K. housing market.

To be sure, house prices continue to gain. But the pace of those gains is slowing as the diffusion index is down to 63 in July from 65 in June and 71 in May. Still, these surveyed values, which are net diffusion indexes, show that on balance there are more prices increasing than decreasing since the reading for July is over 50. Viewed as a percentile standing on data back to 1999, the current three-month trend for the price diffusion index has been higher only about 8% of the time. On this observation alone we might think some weakening is in order.

The clear take away from this survey about prices is that they're still moving up and the upward momentum is still significant. However, a second and perhaps more important take away from this is that the breath of the improvement in the index is shrinking. Recently in this cycle - as recent as April of this year, and February - the house price diffusion index had values as high as 78. Back in June and July of a year ago, the house price index had values of 80 in July and 83 in June.

These conditions have changed as house price expectations have withered; expectations for three-months ahead fell to a net reading of +1 in July from +2 in June and from +12 in May; over the last three months this metric averaged +5; over six months it averaged +16. Clearly house price expectations are diminishing and although the net readings are still positive that is an outlook for prices to rise that is now down to its thinnest possible margin of one-point. Viewing this reading of price expectations against historic data, price expectations have been stronger than this nearly 58% of the time. The metric for price expectations is now below its historic median. And remember this is a thinning and a narrow margin for expected price increases in an economy with severe rising inflation in other prices.

At the same time, new sales log the value of -13 in July which is a very slight improvement from the -14 reading in June. New sales had slipped to that level from -5 in May. The six-month average for new sales has been -4 while the 12-month average is -7. Actual sales have been logging net negative values for some time, but clearly the weakness has just ramped up and gotten more severe.

Expectations for three months ahead echo these changes but with a bit more emphasis. Sales expectations in July slipped to -20 from -11 in June and to minus-one in May. Their six-month average is at zero while their 12-month averages is at +7. Sales expectations have averaged positive numbers for 12 months and flat numbers over six months; this series this has transitioned into a relatively steep negative outlook with the July reading of -20. The July reading, in fact, has a standing in the lower 3.2 percentile of its historic queue of readings on sales expectations. Sales expectations are weaker than this only about 3% of the time. And this is not surprising because actual sales have slipped to a ranking below the 25th percentile so that they are weaker than their current level only about one-quarter of the time. Current and expected-future sales erosions are in sync

Table 2 (below) sheds some light on these developments that is for the most part generalizable to just about any economic time series. In most cases, expectations are extrapolative. We can see that in this table where we look at correlations among the components that are presented in Table 1. Here we look at correlations various pairs looking at house prices, house price expectations, house sales expectations, new sales, and consumer confidence.

I have in Table 2 highlighted two pairs of cells. The darker highlighting compares house prices and their correlation with price expectations. We see here a very strong correlation the strongest in the table between what is happening currently with house prices and what is expected to happen with house prices in the next three months (0.87). The second dark correlation is between new sales and sales expectations. This correlation at 0.72% shows that actual new sales have a strong correlation with expected sales in the future. What a surprise! In both, the case of prices and in the case of sales, expectations for the future are formed based upon the momentum in the current economy. In addition, we find a moderately strong correlation between sales expectations and price expectations as well as new sales and price expectations. Apparently any current or future change in sales stimulates price expectations. It's interesting that house prices and new sales have a correlation of only 0.42, but sales expectations and price expectations have a correlation of 0.63 roughly 50% higher. The strongest correlation between sales and prices does not occur in real time data but occurs and expectations for the period ahead.

These correlations can help to guide us on what to expect in the future. Sales expectations have fallen hard, and they were leading the weakness in new sales. And for prices it's also true that price expectations are weaker and are weakening faster than actual prices. But these two pairs of series tend to be highly correlated so the weakness in the expectation series is likely to be a precursor of price is and sales weakening in the future. This also raises the question of whether expectations drive prices or current events drive expectations. On the way up current strength may drive expectations, but on the way down expectations may lead simply because they are more flexible. This is not just because they are expectations series but because they are expectations series that have high correlations.

Interestingly in this framework consumer confidence does not have very high correlations with anything. The highest correlations for consumer confidence are with current house prices and house price expectations. They post correlations in the region of 0.3 and 0.4. The correlation of confidence with current sales is zero; with sales expectations it's a weak 0.2.

Consumer confidence decidedly is very loosely linked to events in the housing market either to new activity or the price action or to current conditions or future conditions.

On balance, what we see from the RICS survey is that prices in the housing market are strong and are expected to continue to rise; That condition will not persist for very long, however. Activity already is slowing, and it's expected to slow even more. Similarly, price expectations paint a more dismal picture than do the results for prices in the current economic environment.

The 800-pound gorilla in this room that we've not spoken of is the Bank of England that is raising interest rates sharply. That, of course, has an impact on mortgage rates and mortgage rates have an impact on housing costs and affordability - and so on. However, with inflation as high as it is, this is not simply an exercise of assessing some increased carrying cost of a house through a mortgage rate rise but also assessing the risk that with interest rates chasing after such a high inflation rate, mistakes can be made. A recession could emerge and there could be more damage, pain, and economic dislocation in the future. None of these things is good for the housing market, for housing prices, or for future activity.

The housing survey tells us something about the activity in the housing sector, which has some current strength but can’t really be evaluated in isolation from the economy. In some sense, analyzing housing on its own, is like rearranging deck chairs on the Titanic. The real question is what's going to happen with the economy. Fortunately, there's more uncertainty about what's going to happen with the economy than there was about what's going to happen with the Titanic.