If the UK economy is still in recession, why are London house prices hitting new records?

We received word today from the British government that GDP in the UK contracted for a record sixth quarter in Q3 2009. I like Neil Hume’s headline on this one, “GDP shock flop.” If you were listening to the BBC’s Wake Up to Money this morning, you would have expected growth. The fact is economists had anticipated growth of 0.2% quarter-on-quarter. Instead, what we got was a contraction of 0.4%. Shock flop indeed.

(Wake Up To Money audio here): Wake Up To Money

Bloomberg puts the right spin on things:

Britain’s failure to escape the worst recession since World War II may force the Bank of England to increase its bond-purchase plan next month, economists said.

Seven months after Governor Mervyn King’s central bank started a 175 billion-pound ($287 billion) program to rescue the economy, the Office for National Statistics said today gross domestic product unexpectedly shrank 0.4 percent in the third quarter. None of the 33 economists surveyed by Bloomberg predicted a contraction.

“Having pumped in so much money and still seeing a decline in GDP is damaging from a perspective of confidence and expectations for recovery,” said Stephen King, chief global economist at HSBC Holdings Plc, in an interview with Bloomberg Television today. “They’ll be thinking very hard about whether to extend quantitative easing. They need to do something to show they care about the economy.”

Britain is still mired in recession even after pledges of about one trillion pounds in stimulus and banking aid from the Bank of England and Prime Minister Gordon Brown. King, whose push to expand bond purchases to 200 billion pounds in August was defeated, may win more support at the next Bank of England decision on Nov. 5.

The yield on the two-year gilt declined 6 basis points to 0.88 percent after the GDP report. The 10-year gilt yield slipped 3 basis points to 3.67 percent.

I would add that Sterling is getting crushed in the foreign exchange market – even against a weak US Dollar.

So, riddle me this: if the economy is so bad, why are house prices in London at an all-time high? The explanation I came up with on Monday was that this is the natural response to easy money when the economy has a large output gap – namely asset price inflation. And this is certainly helping to pad bonuses in the City of London, a contributing factor to the increase in residential property prices in London.

Meanwhile, in the rest of Britain, the only thing keeping the country from economic freefall is budget-busting government stimulus. The Telegraph’s Angela Monaghan has a good article out today showing the emergency measures still in place including record low interest rates, quantitative easing, sales tax cuts, and the car scrappage scheme, not to mention the government’s backstops in the financial services industry. Where this leads is anyone’s guess at this point.

What should be clear, however, is that now is not a good time to tout a need for people to “tolerate the inequality as a way to achieve greater prosperity for all” as Lord Griffiths has done. He only brings greater scrutiny onto the financial sector. I found this statement particularly unconvincing:

I believe that we should be thinking about the medium-term common good, not the short-term common good … We should not, therefore, be ashamed of offering compensation in an internationally competitive market which ensures the bank businesses here and employs British people

This is an argument for good times, not recession – and even then one must question whether large bonuses in the financial sector are truly in the medium-term common good.