UK housing market ; short term blip or steeper fall in prospect?

The UK economy defied the consensus expectation of a slowdown last year following the Brexit vote, and fears for the housing market were not realised.  The last few months have reignited concerns about both, however, and the news that the Bank of England is  now split on whether to raise interest rates ( a 5-3 vote to maintain the status quo)  won’t help.

House prices have certainly cooled. The Nationwide index for May showed annual house price inflation at 2.1%, the softest pace in four years, with a clear slowing trend; the index has now fallen for three consecutive months, by a total of 0.9%. The picture from the Halifax index is similar, with annual inflation slowing to 3.3% in May, from 6.5% in December. Both indices are based on mortgage lending and the Office for National Statistics (ONS) publishes a broader  but less timely measure, based on Land Registry transactions,  which shows an annual rise of 5.6% for April, albeit also pointing to a slowing trend.  The RICS data, based on a survey of chartered surveyers operating in the residential market.  also reveals a softer market. with a net 17% of respondents in May expecting prices to rise, the weakest reading since the summer of 2016. Buyer and seller inquiries were also seen to have cooled.

Are UK  house prices excessive? The average price in the UK is now £209,000 according to the Nationwide, or 48% above the cycle low in early 2009. Prices are also now well above the previous peak ( £186,000) and are 5.3 times the income of  First Time Buyers (FTB) against  a  long run average of 3.6.  However, interest rates are unusually low; the standard variable rate is over 4% but the effective rate on new mortgages is around 2% according to the BoE, reflecting discounts and lower fixed rates. Consequently , affordability measures do not suggest prices are overvalued; the Nationwide data, for example, shows mortgage payments at 33% of FTB income, bang in line with the long run average. Indeed, for most of the UK regions affordability is much better than the norm, the exception being London, although non-resident purchasers are  more significant in that market.

The supply of housing in the UK is widely thought to be persistently short of the demographic requirement, but completions also fell sharply after the crash, declining to 107,000 in England ( which has the most timely data)  from 170,000 in 2007. Completions have picked up again, in response to higher prices, rising to over 140,000 in England in 2016, and  the  housing starts data points to a higher total again this year. Yet few argue that supply is  still anywhere near demand.

Net mortgage lending  has been growing, in contrast to Ireland, although at a modest pace  relative to historical exerience, but  now also appears to be slowing, with annual growth at 2.8% in April against over 3% for most of the past year. Mortgage approvals for house purchase, a more forward looking indicator,  fell below 65,000 for the first time in six months in April.

This all may relate to uncertainty about Brexit and the short term economic outlook, with the election result also likely to weigh on sentiment. In our view the likelihood  of a more prolonged and sustained period of weakness depends upon the labour market, which to date has held up remarkably well;  the employment ratio is at an all-time high, while unemployment  is still making new cycle lows.  One suspects that UK  lenders and the Government  would only become seriously concerned about the housing market if cracks started to appear in employment.

Buoyant UK economy double boost for Ireland, but rates there may rise soon

The UK economy is growing at a pace which is not only rapid but also well ahead of that generally expected at the turn of the year, prompting a scramble from analysts to revise up economic projections and a reassessment by the market on the likely timing of the first interest rate increase, which is now seen early next year or even before the end of 2014.The unexpected strength of economic activity has also left the Bank of England’s monetary policy strategy is disarray, as it had sought to guide rate expectations with reference to the unemployment rate , with a pledge to keep rates unchanged until the former fell below 7%, which to the Bank did not seem likely till 2016. The unemployment rate is now 6.5% and the Bank  has changed stance, rendering its initial foray into forward guidance somewhat of a embarrassment. None of the nine members of the MPC, which sets the BoE’s policy rate, has yet to vote for a rate increase but it may not be long before we see some advocating tighter monetary policy, particularly as house prices are also rising at a heady clip.

The UK economy experienced a severe recession from early 2008 ,as did most developed economies, although the loss of output was smaller than that recorded in Ireland (7.2% against over 12%) and the duration shorter (5 quarters versus Ireland’s 8). The  UK recovery was also much slower than seen in the past, with falling construction and industrial production offsetting an early rebound in services. All sectors are now growing again and GDP in the UK has risen for 5 consecutive quarters, with the last four seeing remarkably steady growth of 0.7% to 0.8%. That left the annual rise in GDP at 3% in the first quarter and the level of output just  below the previous peak so if q2 growth emerges as expected (around 0.8%) real GDP will have marked a fresh high ( Ireland, by comparison,  is still some 5% adrift of the 2007 peak). Moreover, the UK data has yet to be revised to incorporate the new 2010 standard for national accounts, which will no doubt lead to upward revisions to the level of GDP.

The strong pace of growth has had a significant impact on the labour market; employment rose by almost 1 million, or 3.1%, in the past twelve months, taking the employment rate to a record high, while the unemployment rate has tumbled to 6.5%. That support for household incomes has helped to boost consumer spending (which has risen for 10 consecutive quarters) while business investment has also picked up sharply and is growing at a double digit pace. The external sector is not contributing to growth but otherwise one might say the economy  is booming, although few in the UK would use that phrase. One key reason for that is the absence of any significant growth in pay (indeed annual wage inflation was just 0.4% in May) which has prompted cries of a ‘cost of living crisis’ as inflation, although lower of late, has consistently exceeded the 2% official target. Household incomes as a whole have risen ( given the rise in employment) but real incomes have been squeezed and the increase in consumption has been financed through a fall in the savings ratio, which is now under 5% from a 8% in 2012.

Fiscal policy has also been a drag on the economy in general (although not in 2014) with steeper cuts in government spending earmarked for the next few years, while credit growth , although picking up, remains limp by normal standards. Those factors may have an impact on the BoE’s thinking but it is currently wrestling with the issue of how much spare capacity there is in the economy. Most in the MPC  believe it is still around 1% but there is disagreement , with the persistence of weak productivity adding to the uncertainty about the economy’s  potential growth rate. Moreover, asset prices in general have risen and house prices nationally are increasing at a double digit pace and have scaled new heights, with London clearly in boom territory. Central banks now generally believe that they can prick housing bubbles with macro-prudential tools and the UK authorities have already sought to affect mortgage lending but other  argue that a higher cost of borrowing is the most foolproof safeguard.

Stronger growth in the UK have proved a double boost for the Irish economy. Some 16% of  total Irish merchandise exports go to  the UK (the share of services is higher at around 19%)   but it is  a much more significant market for Irish indigenous firms, taking over 36% of food exports , for example. and so growth there is a boon for Irish firms. In addition, the prospect of higher rates has led to an appreciation in sterling, with the euro rate falling to 79 pence, again a welcome support for Irish firms selling into the UK market, although to put that in historical context that  would be parity in terms of the punt/ sterling, hardly a rate seen as very advantageous for Ireland. Nevertheless, sterling’s relative strength is positive for Ireland and the UK currency may have further to rise given the differing outlooks for monetary  policy in the UK and the euro area.