Irish property investors have roamed far and wide of late in search of the kind of investment returns seen at home over the past decade. The new EU accession states seem to be a popular choice, or places even further afield to the eastern extremities of Europe and beyond. But the most spectacular property gains have occurred much closer to home, just across the water in the UK, writes Dan McLaughlin

The average UK house cost over £152,000 (€220,000) at the end of 2004, according to the Nationwide Building Society, against £75,000 five years earlier, a 100 per cent capital return over the period. This upward trend has faltered of late, however, and the UK housing market has clearly slowed, lending support to those predicting a sharp correction or even a price collapse.

The bulk of the evidence is still against this, on balance, and the latest data indicates that the housing market may be stabilising. Indeed, this stability has contributed to a pronounced change in sentiment in the UK financial markets, with expectations of a fall in interest rates giving way to fear of further increases.

A large number of developed economies have seen property booms in recent years, a not-unsurprising trend in the context of historically-low interest rates.

In the case of the UK, official rates fell to 3.5 per cent in 2003, the lowest level since 1955. The monetary easing was in response to a slowdown in economic growth, but the British economy proved very resilient, certainly more so than its larger European counterparts, and growth subsequently reaccelerated last year, pulling the labour market to full employment in the process.

Perfect conditions for a property boom, one might think, particularly given a singular feature of the UK housing market: an inability to supply houses. Completions in 2004 probably reached 190,000, but this represents a 2.7 per cent advance on the 1999 figure, despite a doubling of house prices, and compares with annual supply of over 400,000 in the 1960s.

This rigidity on the supply side means that any slowdown in the market has to come from the demand side, either through market forces (a rise in unemployment, for example) or through a policy decision by the authorities. The former has not materialised, but the Bank of England supplied the latter, initiating a phase of monetary tightening from November 2003. The move saw official interest rates move from 3.5 per cent to 4.75 per cent, a rate maintained since August 2004.

The housing market eventually responded to this increase in borrowing costs, albeit in terms of transactions rather than prices.

Mortgage approvals, for example, fell sharply from the summer of 2004, plummeting to 77,000 in the month of November - a nine-year low from over 120,000 per month in the spring.

Borrowing duly followed this downward trend, with lending secured on dwellings declining to £6.4 billion in November from a monthly average exceeding £9 billion earlier in the year.

Despite this, prices proved to be more resilient, rising modestly in the third quarter of 2004, before remaining unchanged in the final quarter, although this still left the annual price gain comfortably in double-digit territory: prices rose by 15.1 per cent in the year to December, according to the Halifax, or by 12.7 per cent on the Nationwide index.

Other price surveys, based on vendor asking prices, had pointed to some price falls, but these were marginal, reinforcing the view that house prices tend to be sticky downward, and that negative sentiment in the market is more likely to be reflected in activity levels and turnover rather than valuation.

Nevertheless, the softness in the housing market, and related uncertainty about the outlook, contributed to a belief that UK interest rates had peaked and the financial markets began to move tentatively towards the view that the next rate move would be downward.

A slump in retail rates in December also helped, but the past few weeks has seen a marked readjustment. A rate rise is now back on the agenda, with one of the nine members of the Monetary Policy Committee (MPC) which sets UK rates recently voting for such a move.

Stronger housing data has been one factor behind the shift - approvals rose again in December, as did mortgage lending, and January saw house price gains with some indicators pointing to a further price increase in February.

Retail sales also bounced back in January, largely reversing the Christmas fall, and inflation has surprised to the upside in recent months. In addition, the labour market is still extremely tight, so it may well be that the spring will see further signs of stability in the property market. The downside is that, should this materialise, the Bank of England will respond by raising rates, so 4.75 per cent may not be the top of the cycle after all.

Dan McLaughlin is chief economist with Bank of Ireland