Why UK should be worrying about falling US house prices

The most recent Lloyds TSB Scottish house price monitor issued a warning note. "Average Scottish house prices have now risen steadily for 66 months, but a slowdown is clearly evident in the last six months," it said.

A slowdown? Could Scotland be catching the first draught of a chilling wind that is now cooling house prices in the rest of Britain? Even more worryingly, the same chill seems to be occurring in other parts of Europe, such as Spain and France. But most troubling of all, the biggest chill is now happening in America.

The case for arguing that house prices are heading for a dramatic fall is fairly simple. In Scotland, for example, the Lloyds TSB index shows that, since the beginning of 1997, average house prices have risen by about 150 per cent. By contrast, stock market values, as measured by the FTSE 100 index, have risen by about 30 per cent. Thus, the housing market looks suspiciously like a bubble that may burst.

The same housing bubble has occurred all over the world. So some doom-mongers argue that these bubbles cannot go on expanding for ever and must surely burst at some point, just as stock market bubbles always burst.

The counter arguments include the fact that there is increasing demand for houses caused by people living longer, more single-person and single-parent households, and immigrants, of whom there has been a lot, many more than usual, in the past two years. The supply of additional houses, on the other hand, has not kept up, so that puts an upward pressure on prices.

A second counter-argument is that low interest rates have made money cheap. That, coupled with a stable economy operating not far short of full employment, has given people the confidence to trade up, putting more pressure on prices to go up. When you measure what people are spending on their mortgages as a share of their total income, it works out at about 15 per cent, which is not unreasonable.

However, other costs on household income are beginning to bite. Energy bills are rocketing, the costs of using the car are going up, food bills are rising, and, of course, interest rates went up last month.

Even so, Donald Macrae, director of strategy and planning at Lloyds TSB, is happy to stick with a slowdown forecast. Interest rates, he thinks, would have to go up to about 6 per cent before prices falls would set in, and nobody is expecting them to go up by much more than half a percentage point over the next six months.

Still, the doomsters still have a few cards to play. They point out that the English housing market is looking distinctly wobbly. Price surveys by the Halifax and Nationwide showed falls in the south-east and other parts of England in May and June. This week, Rightmove, which runs a website advertising 70 per cent of estate agency homes for sale in England, said it was seeing the biggest fall in prices for two years. Since Rightmove's prices are based on what sellers are asking, it is an indicator about two to three months ahead of the Halifax and Nationwide indices, which record what buyers have paid.

Even so, these two mortgage lenders are still predicting that British house prices will finish 2006 about 5 per cent higher than at the start of the year, citing continuing low interest rates, economic stability and demand out-stripping supply as their reasons.

Supposing these predictions turn out to be optimistic, should we in Scotland be worried? Not much on these grounds, because Scots spend about three percentage points less of their incomes on mortgage repayments than do the English, meaning that we can absorb cost pain a bit more easily. Thus any house price fall in England will be much less pronounced in Scotland.

However, what we ought to be worried about is the American housing market. This week, the National Association of Realtors, a house sellers' trade organisation, said that the number of American homes sold in July was down 4.1 per cent from June and down 11.2 per cent on sales in July 2005. The stock of unsold homes rose to the equivalent of 7.3 months' supply of houses for sale.

Not surprisingly, this is causing some price falls. Prices have fallen in the north-east of the US by 2.1 per cent over the past year, by 0.6 per cent in the midwest, and by 0.3 per cent in the west.

Now, as all housing markets are local, this does not mean that there will be a direct effect on Scottish, or even British, house prices. But if it has an effect on the American economy, that would damage the British economy, which would damage house prices.

The US economy has already been affected by sustained interest rate rises, and there are plenty of signs of a slowdown. Some economists, such as those at Merill Lynch, think that reduced house-building rates, caused by the rising stock of unsold second-hand homes, could knock a full percentage point off GDP growth rates. Against that, most economic forecasters think that continued consumer confidence and rising wage packets will just mean a slight slowdown.

Well, we have to hope that the optimists are right. The American economy is huge - about 30 per cent of world GDP and it consumes about 40 per cent of the additional growth generated annually in the rest of the world. So if it stops growing, that hits our economy badly. Pray that it doesn't, because otherwise our house price slowdown will turn into a crash.

• Apologies: Last week, the wrong e-mail address was printed. As ever, comments, criticism and ideas are always gratefully received at: [email protected].