Is the slowing in the rate of home price increases, a forecast that the economic recovery will slow at the end of 2010?

04/28/2010 2:00 pm EST

Focus: STOCKS

Jim Jubak

Founder and Editor, JubakPicks.com

This is exactly what I’m afraid of for the 12 months ahead.

Yesterday’s numbers on home prices suggest that as the economic stimulus money gradually dries up over the next 12 months, the economic recovery will lose some steam. Not enough to send us back into recession mind you. But enough to slow economic growth below the rate that higher stock prices now reflect.

The Standard & Poor’s Case Shiller Home Price Index, according to data released yesterday, April 27, shows that home prices rose 0.6% from February 2009. This marks the first time since December 2006 that the index has shown a year-to-year increase in home prices.

That’s the good news. The recovery in the housing market continues.

But there was bad news in the February numbers too.

Although prices were up in February 0.6% year-to-year, prices in February actually fell by 0.9% from January.

And this isn’t an isolated data point. The month to month sequential decline from January to February is the fifth consecutive monthly decline in the rate of home price increases.

Perhaps this string of declining growth numbers is just a reflection of seasonal trends: Home buying in the winter is frequently less active than in the summer and fall. (S&P has recently said that it prefers the unadjusted index numbers to the seasonally adjusted numbers since it believes they are more accurate because of the volatility in the housing market. I’m following S&P’s lead and using unadjusted numbers here.)

But it could be a sign that a big initial bounce created by a government tax credit for home buyers is slowing down as the tax credit program winds down. (It is scheduled to expire this week.)

That could lead to slower growth in home prices—and a slowing recovery for home buildrs—as the year goes on. First American CoreLogic, which compiles another home price index, is projecting exactly that. Home prices will fall by 3% to 4% over the next year, First American said, unless there’s another round of stimulus from the federal government.

Falling home prices aren’t good for either the economy or the stock market, but it’s the analogy between the housing market and the general economy that worries me. If home prices, and thus housing sector activity, slow their rate of growth as stimulus money is withdrawn, then shouldn’t we expect slowing growth for the economy as a whole as crisis stimulus money starts to dry up toward the end of 2010 and in 2011?

That question is tough to answer, which in itself is one reason I don’t expect that Federal Reserve to raise interest rates any time soon.

The analogy also suggests that the fiscal 2011 year that begins in October 2010 might be too soon to begin cutting the deficit, as much as in the long-run that’s what the economy needs.

Tightening monetary and fiscal policy too quickly even as the economy slows on its own would be exactly the wrong thing to do.

If only we knew exactly what home prices are trying to tell us.

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