House prices continue to increase

It has been an extraordinary couple of days for data.

Yesterday, the Bank of England produced monthly lending data. It showed three thing. First, net credit into the mortgage market was almost zero, but the number of mortgage approvals was up slightly. Second, lending to the corporate sector has collapsed. The decline was so dramatic that it could be described as apocalyptic. Finally, lending to the shadow banking system is up 50 percent year-on-year.

Today, we received two additional numbers. We had a first quarter GDP revision. It told us that the economy shrank much faster than originally thought. Then, we had the June house price index from the Nationwide. It showed that house prices are recovering quickly. Over the last 4 months, prices are up 3.6 percent. If you annual that rate, then prices are again growing at double digit rates.

In short, the data releases over the last two days tell us the real economy is tanking, credit conditions remain tight in the housing market, yet somehow the housing market is staging a recovery.

The only explanation is that home buyers are using spare cash balances to purchase homes. Why would they do that? Simply because they expect the return on housing to be higher than the return on deposits.

Behind this move into housing is inflation expectations and zero rates on deposits. The Bank of England's quantitative easing means that the writing is on the wall in terms of inflation. It is interesting that the uptick in house prices mirrors the uptick in the CPI inflation rate. Both started rising in February, which was the month that the BoE started printing cash. As for rates, there is little prospect of a turnaround to compensate for the expect loss in purchasing power.

The only thing holding back a massive jump in house prices is the lack of credit. However, if this should turn around, and banks begin to crank up lending, then we are in real trouble. The UK economy will hurtle uncontrollably into renewed bubble.

If this happens, everything will be in the wrong place; near zero interest rates; an exploding fiscal deficit, and government guarantees on banking lending. I shudder to think how the Treasury and the BoE would unwind this mess.