Bank of America Merrill Lynch revised an increase to its forecast for home prices. The bank analysts said in a report today that they expect the national Standard & Poor's Case Shiller index to increase 5% this year, up from an initial forecast of a 2.0% gain the bank called in August.

This translates to a gain of 2.1% on average this year relative to last.

According to analysts, the increase in home prices reflects a better alignment of housing supply and demand. For example, the listed inventory of homes for sale has declined to the lowest levels since 1Q05. BofA Merrill analysts said that supply is even lower for new construction homes.

Housing demand has also improved with existing home sales up about 10% on the year and back to summer 2007 levels; not accounting the spike in sales on the back of the homebuyer tax credit.

The improvement in home prices will have a direct impact on the health of the economy; and in the short term it will serve as a boost for consumer confidence, said BofA Merrill analysts.

“Simply believing that prices have stopped falling should provide a sense of relief to households,” the analysts said. “It will also allow households to have greater mobility, generating a more efficient labor market and greater churn in the housing stock. We have already seen a turn higher in consumer sentiment, which is likely correlated with the gain in home prices.”

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