Thursday, June 26, 2014

26/6/2014: You Might Need a Hubble to Spot That Bubble


In my analysis yesterday (here) I argued that Dublin residential property prices are simply showing signs of reversion to trend, not 'bubble' dynamics. Since then, numerous reports in the media produced opposite conclusions, with headlines forcibly putting forward an argument for 'bubble' formation in Dublin property markets.

Over long run, sustainable property prices appreciation should track closely inflation in the economy. So far is pretty much clear. While arbitrary, starting points for trend estimation for Dublin property should start from pre-bubble period of 1999-2001. This is also pretty clear.

So let us apply Consumer Price Index-measured inflation to Dublin residential property price indices and see where the trend is against current reading. The following chart, based on annual series 2000-2013 and May 2014 for current reading illustrates this exercise:



Here's a pesky problem for 'bubble'-maniacs out there:

  1. If property prices expanded at the rate of inflation from 2000 on, current Dublin property prices index should read around 91.2.
  2. If property prices expanded at the ECB policy-consistent inflation target of 2%, the index should read around 89.4
  3. Current CSO index reading is 72.2
So we are somewhere 25-26% below 'sustainable' levels of house prices, if these are measured by inflation-linked price appreciation, or 24% below ECB-targeted rate of inflation.

You do need quite a powerful telescope to spot the bubble in Dublin markets from here. Which, of course, should not be read as 'there is no bubble', just as 'we can't yet tell anything about bubble being formed'.


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