PropertyInvesting.net: property investment special reports: 203: UK House Prices, Oil Prices, GDP and Interest Rates

203: UK House Prices, Oil Prices, GDP and Interest Rates – modelled

07-05-2008

PropertyInvesting.net team

Oil prices are now getting dangerously high for all UK property investors exposed to their inflationary aspects. To give greater clarify on the potential impact of the high oil prices for UK based property investors, we have prepared a predictive model to help explain the inter-relation between high oil prices, interest rates, GDP and house prices. In summary, if oil prices rise, inflation rises, interest rates rise to control inflation and spending, GDP then normally drops, unemployment rises and house prices then drop. If oil prices rise, inflationary pressure builds in all parts of the economy because oil is the input raw material for most manufacturing and services, either directly (raw material) or indirectly (transportation, commuting, wages, power).

Inflation in the UK is now running at 3.1% - at $145/bbl, it is likely to rise to 4% before dropping back mid-late 2009. But if oil prices rise to $175/bbl, this could add another 0.5% to 1% on the inflation rate and send interest rates still high – by 0.5% to 1% additionally. We believe at this point, the UK GDP would drop to something like 0.4% - close to a recession. Unemployment would likely rise by at least 300,000 to over 6% from its current 5.4%|. All these negative indicators on top of the credit squeeze would undoubtedly send property prices in the UK down further, and for longer.

This is the first attempt we have seen to model the links between oil prices, interest rates and property prices. No-one has a crystal ball, and it’s difficult to judge the consequences of higher tax, lo consumer confidence, low confidence in the UK Government management of the economy and the credit squeeze – the model probably not very accurate, it’s more indicative for your consideration. With our experience in economics, property and the impact of oil, we give this model to provide some insights into the inter-relation between these variables.

The chart shows three scenarios:

Upside (unlikely): Oil drops soon to $115/bbl (from current $145/bbl), interest rates stay on hold at 5% and 2009 UK GDP stablizes at 2.4% - house prices stabilize from August
Middle Case (slightly optimistic): Oil stays stable at $145/bbl, interest rates rise to 5.5% and 2009 UK GDP drops to 1.4% - house prices drop 0.5% per month at least until end 2009
Low Case (realistic, mildly pessimistic only): Oil rises to $175/bbl, interest rates rise to 6% and 2009 UK GDP drops to 0.4% - house prices drop 1% per month at least until end 2009

If oil prices rise to $200/bbl or more, we predict a full scale UK recession and house prices dropping at least 20% over a few years.

The critical point we are making is – we believe UK property prices are directly linked to the oil price. The higher the oil price rises, the lower the property prices will go. This is the main reason why we have given guidance since early 2007 on investing in cities and countries that are positively exposed to high oil prices, as a hedge against what we believe will be increasing oil prices in future years.

This we believe is a key and very important aspect of developing a good property investing strategy. If you are a purely UK based property investor, we would consider holding fire from any property investment at this time, and wait to see what happens with oil prices later in 2008. If they drop and look set to continue this trend (we think this scenario unlikely), this is a buy signal. If oil prices stay stable, this is a hold and selective buy of bargains signal. If oil prices rise, it is either hold (or sell) signal – with further purchases only when turbulence looks set to subside and oil prices drop. Yes – it’s best to buy on the bottom of the market:

If oil prices rise, the bottom is deeper and further out end 2009 to 2010.
If oil prices drop, the bottom is in a few months time and not very deep.
If oil prices stay at current levels, the bottom may be mid 2009 and moderately deep.

The higher oil prices rise, and the longer they stay high, the more attractive countries like Norway, Canada, Russia and Middle Eastern countries look – since their massive new oil wealth will lead to rapidly escalating property prices, whilst oil importing nations will generally see price drop. These aspects are described in detail in our Special Reports outlined below:

The only positive news in relation to high oil prices for UK property investors is:

UK produces half its oil and gas requirements indigenously (North Sea) and is therefore partially hedged against oil prices rises - unlike Germany, France, Spain, Italy, Switzerland, Poland, Czech Republic, Austria and Greece (the same is also true of the USA – it produces half its oil/gas requirements).
The UK is not as energy intensive per GDP as Germany or Holland
Huge oil, gas and mining profits are made from London and Aberdeen based and listed oil/mining companies – hence these profits are often liberated within these two cities and help these cities economies.
Large Middle Eastern, Russian and African oil wealth is re-invested in London property, financial services and business
London is less energy intensive than most other UK cities and country areas.

So for UK investors, if you invest in the UK, it’s best to focus on London and Aberdeen as oil prices stay high (or areas within a 50 mile radius of these cities). And best to avoid Wales, Midlands and manufacturing centres in England and Scotland that are energy intensive compared to their GDP – remote countryside areas will also suffer (less tourism, car travel, high agricultural costs).

We hope you have found these insights helpful for your property investing strategy and risk management.

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