New Mortgage lending continues to slow amid fall in approvals

Irish household incomes are rising strongly, driven by robust employment growth, and that would normally support the demand for mortgages, particularly against a backdrop of rising property values and low interest rates . Indeed,Irish financial institutions have seen new mortgage lending rise year on year since 2013, albeit at an erratic pace,  reaching €7.3bn in 2017 from under €2.5bn four years earlier. The number of new mortgages drawn down  annually for house purchase rose from 13,000 to over 29,000 over that period.The strength of new lending also began to offset mortgage redemptions a year ago  and the annual change in net mortgage lending  has picked up since, to 1% in September.

The market has had to adapt to  constraints on new  mortgage lending, introduced by the Central Bank in 2015, including a number of changes to the controls, most notably from the beginning of  this year, with FTB lending  allowed in excess of the 3.5 LTI limit reduced to 20% from the 25% observed in 2017. The constraint applies to lending over the calendar year  as opposed to approvals,  and the latter may not translate into actual drawdowns for a number of reasons. Banks have therefore become much more cautious on approvals, paricularly to FTB’s,   and approvals  to that segment  have been falling on an annual basis since March, declining by an annual 3.3% in the three months to September.

In fact approvals to all borrowers for house purchase  is also down relative to last year, at  9,741 in q3 against 9,876 in the same quarter of 2017. The relationship between approvals and  drawdowns can vary a lot from quarter to quarter and actual lending for house purchase in q3 was stronger than the approvals trend implied, albeit still confirming  a slowdown in the pace of  new lending.

Over 8,700 loans for house purchase were drawn down in the third quarter, 8% up on the previous year but compared with annual growth of 9.4% in the first six months, itself about half the pace seen in 2017. The value of lending for house purchase  is also slowing, emerging at €2bn in q3, up an annual 11% against 16.5% growth in H1. The implication is that the average new mortgage is also increasing, as one would expect given rising house prices, but again there is a noteworthy change; the average  mortgage for house purchase in the third quarter was €228,000, just 3% up on the previous year.

Central Bank research indicated that mortgage controls would dampen mortgage lending and house building  while also impacting  house prices and that certainly seems to be playing out, although the possible effect on prices is being offset to some degree by the scale of non-mortgage buying, which still appears to be running at about 50% of transactions. One other striking feature of the mortgage market is the strength of re-mortgaging, such that lending for house purchase has fallen to 80% of total mortgage lending, from 94% three year ago.

Finally, we have trimmed our estimates for new mortgage lending for 2018 as a whole, with €8.2bn now envisaged, including  €6.8bn for house purchase. The number of loans for the latter is projected to be just over 30,000 from 29,400 last year.

ECB rate rise next year not a done deal

In June, the ECB announced it was likely to end its net asset purchase  programme in December and that it expected to keep interest rates at their present level ‘at least through the summer of 2019‘ , albeit with a caveat relating to inflation developments remaining in line with the Banks expectation of a steady convergence to target. Some confusion ensued as to when the summer actually ends but the ECB has since indicated it is happy enough with market expectations of a rate rise at the September or October meetings next year.

Any change is more likely to initially  involve the  ECB’s Deposit rate rather than the Refinancing rate, and the latter is more significant for existing Irish mortgage holders as Tracker rates account for over 40% of the stock of mortgage loans.However,  it would then  only be a short period of time before a rise in the refinancing rate occurred if the ECB was  set to embark on monetary tightening.

Why has the Governing Council decided to signal a probable rate rise? In part because the EA economy performed strongly in the latter part of 2017 and although growth moderated in the first half of this year, to 0.4% per quarter, that is still above what the Bank considers to be potential, which has resulted in further falls in the unemployment rate. The ECB is also more confident that wages are finally responding to the tighter labour market, and as a result expects underlying inflation to pick up steadily , with the ex food and energy measure forecast to average 1.8% in 2020 from 1.1% this year. As such , the Council is more confident of a ‘sustained convergence’ in headline inflation to target.

In fact headline inflation has been above target for the past four months, oscillating between 2% and 2.1%, boosted by higher energy prices. Yet that is also squeezing household incomes ( wage growth was 1.9% in q2) and core inflation ( which excludes food , energy, alcohol and tobacco ) has remained stubbornly at 1.1% or below in recent months, slipping back to 0.9% in September.

The  economic outlook also looks less robust than it did. The ECB maintains that the risks to EA growth are balanced but at their September meeting  it was noted that a case could be made that the risks had tilted to the downside. Since then , the global outlook certainly seems to have deteriorated amid a backdrop of falling equity markets, rising trade tensions, weaker growth in China, a rising dollar, Brexit uncertainties and  Italy’s apparent willingness to breach euro fiscal rules.

Indeed, some of the hard data in the EA has been noticeably weaker over the summer months and the PMIs have also softened, with the latest reading for the EA as a whole dropping to a 2-year low of 52.7 in October, That is consistent with GDP growth of only 0.2% a quarter and it will be interesting to see whether the ECB reiterates its balanced risk view at the upcoming meeting.

It may be that the current weakness in sentiment and activity proves temporary but what may also concern the ECB is that more forward looking indicators also signal weakness ahead. The major European equity indices are all heavily in the red year to date while monetary indicators are not reassuring; M3  growth has slowed to 3.5% while the growth rate of lending to the private sector has remained becalmed at 3.4% in recent months, with mortgage lending slowing a little to 3.2%.

It is unlikely that the ECB will do a volte- face on its forward guidance at this juncture but the risks to their view on inflation have risen and it is not a done deal that rates will rise in 2019.