18 July 2014
The macro-prudential interventions announced by the FPC in late June are finely calibrated and precautionary, but could nevertheless reinforce April’s Mortgage Market Review in tipping the UK towards a more conservative lending environment.
It is difficult to gauge the short-term direction for house purchase activity and mortgage lending more generally, given unknown regulatory impacts, regional differences and uncertainty as to when the first in a series of interest rate increases will take place.
Recent economic news has been something of a mixed bag for policy-makers. Slower rates of growth in construction and industrial output may herald moderately weaker GDP growth for the second quarter.
The jobs position continues to tighten, with record levels of employment and the headline rate of unemployment nudging a little lower to 6.5% in May, But, earnings growth remains subdued and has been persistently lagging behind inflation since 2009.
Meanwhile, there was a sharp rise in the headline consumer price index – to 1.9% in June, up from 1.5% in May.
It is difficult to know how the MPC will weigh up these conflicting developments, when framing its monetary policy judgements.
While economic forecasters remain divided, the Treasury’s latest compilation of economic forecasts suggests that sentiment is building in favour of the UK later this year seeing its first rise in official interest rates since July 2007.
The major development for mortgage lenders over the past month has undoubtedly been the recommendations of the macro-prudential regulator, the FPC, that banks should check that new borrowers could afford their mortgages if interest rates were to rise by 3% over the first 5 years of the loan, and that there be a 15% limit on the proportion of new mortgages with loan to income multiples (LTIs) at or above 4.5 times.
In taking these actions, the FPC has stuck closely to the policy breadcrumbs trail that it has carefully laid over several months, most specifically by landing on measures which are intended to be cautious and proportionate.
The two measures are intrinsically linked, to guard against a situation where today’s income stretch becomes a source of material payment stress as the UK returns to more normal interest rates.
The context here is the growing incidence of higher LTIs over the past few years. While historically low interest rates mean that typical debt-servicing costs are low, the Bank has estimated that the proportion of mortgages with debt-service ratios at or above 35% would mushroom from 2% currently to 21%, if mortgage rates averaged 7%.
Chart 1: New loans for house purchase with LTIs at or above 4.5
It is worth noting that the Bank continues to appear reasonably untroubled by current market developments. Indeed, it is anticipating further recovery in mortgage lending, housing market transactions and house prices through to at least 2016.
But the FPC is deliberately acting early, in order to insure against a marked future loosening in underwriting standards and unsustainable build-up in personal debt levels.
The measures are designed so as not to tighten current market conditions. As evidence, over the past year, the proportion of new mortgages where LTIs are at or above 4.5 has been about 11%, that is comfortably below the 15% threshold now proposed.
The FPC measures may nevertheless have some modest short-term market impacts. Lenders who have relied less on the interest rate stress test within their affordability decisions may be slow or reluctant to re-engineer their models. Alternatively, lenders more generally may seek to maintain a safe-harbour buffer below the 15% LTI cap.
While such impacts may be relatively small in aggregate, they have the potential to reinforce the more conservative risk appetite engendered by MMR rules.
Any tightening of affordability metrics is likely to have more pronounced impacts on the London market and first-time buyers more generally (especially the latter, as the Treasury has also decided to apply a universal LTI cap of 4.5 times for purchases under the Help to Buy mortgage guarantee scheme).
Housing and mortgage markets
Although there is growing evidence from RICS and others that the London market has softened, this is likely to be offset at least in part by recovery elsewhere.
Recent indicators are consistent with a modest slowdown in the pace of activity nationally over recent months, but we cannot yet say with any confidence what discernible impacts the MMR may be having.
As our May lending figures show, mortgage lending continues to be well above year-earlier levels, but the pace of growth is certainly softer than earlier in the year.
Chart 2: Loans for house purchase, year-on-year % change
While house purchase numbers have held up well so far, this looks increasingly at odds with the progressive contraction seen in Bank approvals data over the past four months.
Remortgage activity retreated in May - and was lower both compared with April and a year earlier - although this may be a temporary effect arising from the fresh underwriting of such loans that MMR rules now require.
Our forward estimate is that gross lending was £17.5 billion in June. While this would be the strongest showing since last October, and up 4% on the May figure and 17% year-on-year, this is likely to have been the second month in a row when the seasonally adjusted figure was below £17 billion.
- Name: Bob Pannell