What would a run on sterling driven by property outflows look like?

Pretty bad, to be honest

The British property market took a turn for the worse this month, with prices falling for the first time since the (very temporary) dip in prices during the lockdowns.

This is not suprising. With rising interest rates, and first-time buyers making up around 30-40% of mortgaged buyers, it is all but inevitable that the market will severely weaken in the coming months.

This will have consequences for British economic growth going forward as investment in construction and development is an enormous component of the British economy. This is true in London, but it is also true in regional cities like Manchester, Liverpool and Birmingham which are populated by new high rise apartment blocks — many of which, from what I can tell, are themselves rather unpopulated by actual residents.

But perhaps an even more interesting question is what a downturn in the property market might mean for the capacity of Britain to finance the current account deficit this winter and next year.

Foreign buyers currently own about £90.7bn worth of British property. What woiuld we compare this against? Let us take Deutche Bank’s famous projection for a current account deficit next year of 10% of GDP. 10% of 2023 GDP is around £319bn.

So, what would it take for the market for foreign bought property to generate a crash in sterling. Imagine the following scenario: in the first quarter of 2023, foreign investors get nervous about both the British property market and sterling. This leads to one third of them rapidly exiting the market — so around £30bn worth of wealth heads for the exit.

In the first quarter of 2023, the current account will be around £80bn is the projections are correct. This would mean that, all else being equal (ceteris paribus as economists say), there would be a shortfall of financing of the current account deficit of almost 40%.

But all else would likely not be equal. In financial markets, fear breeds fear. It seems likely that if foreign property owners were this spooked, foreign holders of gilts and equities listed on the FTSE would also rush for the exit. That could entail an almost complete drying up of financing for the current account — what economists call a ‘;sudden stop’ — and would precipitate a sudden collapse in the value of sterling.

What our analysis has shown is that foreign-owned property is a serious asset class when it comes to financing the current account deficit. In itself, it could generate a limited but serious run on sterling. But if the property market sank at the same time as other sterling asset markets you can easily imagine a sudden stop doosmday scenario.

Of course, if you are reading the British financial press you’ll ‘know’ that none of this is happening. The energy crisis has been resolved — hurrah! Funnily enough, as the financial press are pumping out optimistic articles on energy, the British government “tests energy blackout emergency plans as supply fears grow”. Apparently the civil servants aren’t reading the optimistic forecasts in the press.