House prices up 15% in two months and could double

In the US, the collapse of house prices since mid-2006 has been followed by the sub-mortgage crisis since last August. The policy response from the Federal Reserve has been to lower interest rates dramatically. This will allow banks to recoup their losses by increasing the spread between borrowing and lending charges, and gradually put a floor under house prices.

This dramatic loosening of monetary policy has had the nasty side-effect of stirring up commodity price inflation, most particularly in the oil market. For an oil-exporting country like the UAE, this means huge additional liquidity is flooding the banking sector with money supply rising at 37%.

Dollar peg

At the same time the UAE has its currency pegged to the US dollar so the nation has to track US interest rates downwards. Hence you have interest rates falling at a time of rising inflation, in short very high negative real interest rates.

That means the economy is effectively paying you to borrow money. So is it any surprise that there has been a huge dislocation of funds into real estate, further increasing upward pressure on prices?

This is not over yet by a long way. What message does a gain of 10%-15% in two months send to the marketplace? What greater encouragement do investors need when alternative investments all over the world look sick?

Well, how long will this last? Price gains of this intensity are not usually sustainable for long. But a 50%-100% increase in property values over the next six to 12 months is quite possible. After that the market would move sideways awaiting confirmation of its optimism.

Oil prices

Now with Goldman Sachs predicting an oil price spike of $150-$200 within the next 18 months that would suggest very much high property prices are obtainable and will be sustainable at least within that timeframe.

And let us not forget the supply side argument either. UBS has forecast that new property supply will begin to impact on the Dubai market by 2010, and if that came along with a downshift in oil prices - perhaps due to a global recession - then that would finally signal the correction.

But not before house prices reached very much higher levels than we see in the market today, with even observers from the world's most highly priced property markets becoming shocked by prices in Dubai. Currently they still find the market good value.