UK property prices in 2011 - up or down?

So what is it going to be? A return to the bubble years, or a renewed property price crash?

Recent price developments haven't provided much guidance. As the chart illustrates, UK nominal property prices have been treading water for the last nine or so months. They have shown little inclination to go either up or down. Insofar as a trend can be identified, the market appears to be weakening very slightly. Since August, prices are down 0.5 percent. However, that is hardly the sort of decline that will give the nation's rapacious real estate agents sleepless nights.

UK property prices ended last year on a downswing. In December, the Acadametrics national index fell 0.2 percent, compared to the previous month. For the year as a whole, house price inflation was just under 3 percent, and therefore slightly lower than the overall inflation rate. In real terms, house prices fell by the smallest of margins.

Most predictions point to a further round of price declines in 2011. As always, much will depend on the future path of interest rates. If the Bank of England starts to hike the bank rate, the conventional wisdom is that the housing market will weaken.

However, we live in bizarre times where the normal rules no longer apply. In the short run, a rate hike from low current levels won't make much difference to mortgage affordability. Any homeowner with half a brain cell will have already locked in their super low rates when they remortgaged.

Ironically, a rate hike will signal improved economic conditions and an exit from the financial crisis. This will strengthen consumer confidence, which might spillover into the housing market. A rate hike will also improve the functioning of credit markets, which could also increase mortgage approvals.

However, if the Bank delays a rate rise, bad things will happen. It will prolong the pervasive sense of turmoil and weaken consumer confidence. It will also give further credence to the growing expectation of more inflation. If the delay extends into the second half of the year, higher inflation expectations could push long run interest rates upwards, and open up the possibility of a slowdown in GDP.

So how does this inverted story - where a rate hike buttresses consumer expectations and the housing market - fit into the long run assessment that property prices are overvalued? The 2008 house price crash was unusual. Prices fell in nominal terms, which is a rare event in property markets. In previous corrections, the downward adjustment was slow, with rising inflation and incomes doing all the heavy lifting. Homeowners are invariably reluctant to accept nominal price reductions, but seem prepared to absorb an inflation induced adjustment. The future correction is likely to return to a more normal pattern of seller denial, and a slow deterioration of home values as consumer price inflation outstrips house price inflation.

An early rate rate might affect the adjustment path, but it will not affect where prices will be over the long run. Within five or so years, the UK property market will have given up all those gains recorded during the bubble. A delayed rate hike, ironically, might actually speed up the adjustment path, since it will both weaken consumer confidence, and strengthen the growing inflation momentum that is now building up within the UK economy.

For what it is worth, and it is not much, I think the Bank of England will delay the rate hike. Accordingly, house prices will weaken during the first six months of the year. Inflation will pick up, and by mid-year some alarming consumer price index numbers will begin to be printed. At first, there will be denial within the MPC, but eventually there will be a panic rate hike, probably towards the end of the summer.

Once the MPC have come to their senses and begin normalizing the economy, a sense of calm will prevail. Overall, it will be a good thing, but as always, UK home owners will over-react. Towards the end of the year, house prices will temporarily stabilize, and perhaps rise.

So where will house prices be this time next year? It is only a personal view, but I think they will down slightly on where they are today. although I would not rule out the possibility that they are flat, should the MPC raise rates earlier than anticipated.

(Finally, just be clear, this my humble opinion, and it is for entertainment purposes only. If you are in the business of buying property this year, make your own mind up. I make no recommendation to buy, hold or sell.)