Exploring the relationship between inflation and house prices


Fig 1: CPI inflation v Nominal House Prices

South Africa has a history of high inflation. Inflation targeting has successfully brought inflation down to low single digits since 2003. Up until 1993 and at least since 1982, CPI inflation rates were actually double digits. Historically we have seen an inverse relationship between inflation and house prices. When inflation was high, house price growth was low. When inflation was low, house price growth was high.

If we look at the BRIC countries, China’s official inflation rate currently is 5.1% in December 2010, up from 1.5% at the beginning of 2010. India’s inflation is about 7.5%, but is expected to rise further since food prices are surging at double-digit rates. Brazilian inflation was 5.91% in December, Russian inflation is currently running at 8.8%.
South African December 2010 inflation: 3.5%.

With inflation currently so low, and with other emerging markets being at a higher level and rising fast, it is highly likely that SA will not be able to keep inflation at the current level.

It will be interesting to track how inflation affects nominal house price growths over the coming months and years as the new property cycle unfolds. If inflation rises again, we can expect to see a further dampening affect on property prices in the near-medium term.

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5 Responses to Exploring the relationship between inflation and house prices

  1. Frank says:

    Why has inflation been so high in SA in the past few decades? One theory of inflation relates inflation rate to employment rate – if most people are employed, then people are cash flush, and there is a glut of employment opportunity, giving job seekers further negotiating power for even higher wages. The opposite is true in periods of low employment rate The so-called NAIRU (Net Accelerating Inflation Rate of Unemployment) is that rate of unemployment at which inflation begins accelerating. In developed economies this NAIRU looks to be about 6%, and some countries have policies that keep unemployment above this level.
    So, how might this apply to SA? In the past few decades, the economy has been driven by mid-high earners (white South Africans), and the stats tell us that their unemployment rate has been well below 6% for some time prior to 1994. Now that the economy is more balanced, and unemployment has risen above 6% for mid-high earners, we have low core inflation (we have had volatile food and energy price fluctuation, but this masks core inflation rate that must exclude these volatile elements to discern long term trends).

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    • Interesting point, it will be great to get hold of employment figures for this group.

      After inflation targeting was introduced in a speech in 2000, success in keeping inflation down allowed banks to reduce prime interest rates. During 2003 alone interest rates were cut by 550 basis points (5.5%), while between 2002 and 2006 interest rates were cut by a total 650 basis points (6.5%).

      Lower interest rates saw consumer spending rise, cheap money fuelled the construction sector and housing boom. The sale of new vehicles reached record levels.

      Monetary policy will play a key role too going forward I would think?

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  2. CJ says:

    I pointed out in my comment on the real houseprice graph last week that if we replicated what happened between ’84 to ’97 then the real house price will drop the 50% it needs to. Looking at this graph it becomes apparent why that happened – the house price increases were BELOW the inflation rate for most of that period.

    Compared to after that where house prices were way above inflation during the bubble decade.

    So I expect we will be seeing a repeat of that earlier pattern where HP growth will be way below inflation for the next decade or so. With this in mind your expected HP growth over the next 4 years seems far to high. I would have thought we would see the kind of blip down we saw in ’85.

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    • Yes absolutely. Inflation is going to be key to monitor and its affect on real house price growth over the next decade. Can South Africa continue to keep inflation down? The world is at a very uncertain point right now wrt inflation…

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  3. Frank says:

    Uncertain inflation? I’m not so sure. In the US core inflation is very low (not much more than 1%) and trending downwards. So much for the US inflation dooms-dayers, who have been waiting for QE related inflation for a couple of years. Fortunately Bernanke has been able to fend off the deficit hawks and kept just enough liquidity pumped into their system to avoid the kind of abortion that has been self-inflicted by the Brits. It’s a pity Bernanke could not have done more, as the US would have retained greater employment rates and fiscal recovery would have been faster. Because the fed support was so constrained, the US will not see high core inflation for some years (food and energy inflation, yes, but that is highly volatile if you look at the US data, and core inflation is a far better indicator). Same in EU and Britain – they may have worst of both worlds, stagflation, as supply constraints drive higher food and energy prices, but there is no increase in demand due to unnecessarily self-inflicted high unemployment. The real reason China has high domestic inflation is mainly because it refuses to allow its currency to rise in value? A global distortion that is falsely creating a “developing world inflation” signal? This cannot last forever, and so a rerate of their currency will hopefully mute their inflation. Current energy and food price increases seem supply-constraint driven. With continuing liquidity constraints and low employment generally, increasing core inflation does not seem an imminent threat.

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