• Our view that house prices will ultimately fall by 35%, or another 25% from here, still holds. However, with the economy heading for a recession lasting for at least two years, we now think that those falls could be seen by late 2009 or early 2010, a year earlier than our previous forecast.
• Government bailouts of the ailing banking sector, both here and abroad, have hopefully averted fullscale meltdown of the UK and global banking systems. But they will not prevent a major fall in bank lending to households and companies. We now think that the UK economy will contract by 1% in 2009 and by 0.5% in 2010. We also expect unemployment to rise by almost 1.5 million.
• However, the deeper recession does not mean we are necessarily facing a deeper housing market correction. After all, our previous forecast already factored in a significant rise in unemployment and some falls in GDP. It also allowed for house prices to overshoot our estimate of fair value a little. What’s more, we expect inflation to drop rapidly, allowing interest rates to fall to 2.5% next year, if not lower. At the margins, lower interest rates will help to prevent a larger fall in house prices. But, the deeper recession is likely to mean that the pace of house price falls will intensify.
• Given time, the Government’s bank rescue package might help to ease the mortgage credit squeeze. However, with expectations of further house price falls widespread and with unemployment rising, a lack of mortgage demand, not supply, may be the bigger problem next year. We expect transactions to fall to around 650,000 this year - half their 2007 level, with only a modest pick-up in 2009.
• Our analysis suggests that regional house price falls will be more evenly distributed across the country than they were in the early 1990s slump. However, valuations look most stretched in the South West, Wales, Northern England and Northern Ireland, and these regions will see the largest drops.
• Although tenant demand is likely to remain healthy, the rise in supply of rented accommodation and the larger increase in unemployment that we expect will bear down on rental growth and our forecasts have been reduced. At best, rents will match average earnings growth but not exceed it.
• Of course, the outlook is particularly uncertain at present. Much will depend on the success of the bank bail-out in re-opening the credit markets. But, while there are both upside and downside risks, in our view, a 35% peak-to-trough fall in house prices remains the most likely outcome.
