One thing I’ve noticed is that when people look back at house price changes, they tend to somehow ignore the contextual setting, in particular the impact of inflation. Whilst actual changes in house prices are important for individuals as it determines how much equity they have in their property, what also needs to considered is the ‘real’ change when inflation is taken into account.

If you look at the seasonally adjusted HBOS index, the index peaked in May 1989 at 227.4 and fell to its lowest point in this cycle in June 1995 at 197.3, overall a peak to trough decline of just under 14%. However the decline in real terms when inflation is included was actually much more severe. The early 1990s was a period where the government struggled to get Inflation under control. At the start of the 1989 decline, inflation (RPI) was at 8.3% and peaked at 10.9% in October 1990. When you analyse house price inflation and include the real effect of inflation, the decline was much more severe than the headline figures suggest. With inflation included the end of the house price decline was October 1995 when house prices in real terms were just 55.97% of the May 1989 values, a 44% drop!

As you will see from the graph below it took until early 2002 for ‘real’ values to recover back to 1989 levels (this of course this doesn’t mean or infer house prices became overvalued at this point as some very analysts have suggested).

Whilst the current house price decline is indeed severe, we are looking at inflation falling sharply with a widespread view of RPI falling below 1.0% within the next 12 months. Taking this into context, the decline in prices we are seeing is still as yet far from the issues we experienced in the first half of the 90s.

As always, the lesson here is don’t take history out of its context…