Market commentary

Economic backdrop 

The unprecedented support measures taken by authorities worldwide have underpinned the financial system. But against the backdrop of a marked improvement in the global economy, the UK has been slow to emerge from its worst post-war recession, and remains vulnerable to any future adverse shocks.

While the jobs market, helped by widespread pay moderation, has performed better than expected, unemployment is still likely to peak at or near the three million mark next year. The number out of work may now peak rather lower and earlier than had been feared, but will still weigh on the housing market.

Many commentators, including the Bank of England, expect our recovery to be protracted and relatively weak.  Once the general election is out of the way, we will likely see a process of fiscal retrenchment, comprising spending cuts and tax rises, that will persist for several years at least.

However, the upside to a relatively sluggish economic recovery is that monetary policy is likely to remain loose for some considerable time with little pressure on the Bank of England either to increase official interest rates or reverse QE through next year.

Mortgage arrears and possessions

One consequence of economic weakness has been low mortgage rates and the beneficial impact on mortgage arrears. Our initial forecast for this year has proved far too pessimistic, as can be seen in the Q3 2009 data published today. Low rates have meant fewer households falling into arrears as a result of temporary disruption of incomes, and a much greater range of forbearance and other coping strategies for those who face payment difficulties.

Rising unemployment, and the lagged impact of earlier increases, will mean that more borrowers fall behind on their mortgages. But the increase is now only expected to be modest due to the off-setting effect of low interest rates. The number of borrowers behind by 2.5% or more of their mortgage is forecast to be 195,000 at the end of this year, unchanged from the end of the third quarter, and edge up to 205,000 by end-2010.

Possessions too have been much lower so far than we feared earlier, although numbers may continue to rise as borrowers with longer-lasting causes of financial hardship run out of options. Under the assumption that interest rates remain low and government support measures are maintained at current levels, we expect a relatively modest increase in the number of possessions from 48,000 this year to 53,000 next.

Housing and mortgage markets

The strength of the housing market over recent months has been surprising.  Recovering house prices appear at least partly to reflect short-term drivers, such low volumes of new-build properties, few willing sellers, and a relatively high level of cash and overseas buyers. It is not certain that these will continue into 2010. Sales activity has picked up sharply from the very low levels seen early in 2009, but remains far below what might be considered “normal”. House purchases for 2009 as a whole are set to be lower than in 2008 and likely to be the weakest since the war. It is hard to build a case for a dramatic upturn until the wider economic picture improves materially, although we do expect 2010 to see slightly higher transaction levels than 2009.

However, significant house price falls over 2008 and early 2009 mean that large numbers of home-owners have low or negative equity, and this effectively limits both their ability and willingness to move house and to remortgage.

Meanwhile, low mortgage rates mean that many existing borrowers find themselves on attractively priced tracker or other variable rate products, with little incentive to switch their mortgage. The result has been a sharp contraction in remortgage activity (which has pushed gross lending volumes lower) and downward pressure on lenders’ margins. With interest rates expected to remain low, there is little reason to expect this to change next year.

A recovery in wholesale funding markets has allowed large players to tap securitisation and covered bond markets recently but investor capacity for UK assets is likely to remain modest for some time yet. While funding markets are certainly looking more healthy, the overhang of refinancing commitments from maturing bonds and government supported schemes is still likely to weigh heavily on lenders’ appetite and ability to lend more next year. Low levels of retail savings growth also limit the flow of available funding.

This suggests that we may only see a modest overall growth in mortgage lending volumes next year. To all intents and purposes, the UK mortgage book is stagnating at present, with repayments broadly matching new lending. 

Overview

Taken overall, the most likely outcome for next year is modest progressive improvement in the housing and mortgage markets, and only a modest deterioration in the number falling behind on mortgage payments. But fiscal measures have the potential to unsettle the wider economic recovery if the tightening appears premature or overly aggressive. This must therefore be seen as a key downside risk. 

The case for a slow but progressive return to more normal market conditions rests critically on the assumption of little if any change in UK interest rates (albeit that low rates further constrain funding to some parts of the lending industry). This seems plausible if the authorities and financial markets feel confident about the short-term nature of effects arising from the reversal of this year’s VAT cuts and any post-election increases in indirect taxes. But there are additional uncertainties, including how the US and other major economies address their major imbalances, and the potential these have for currency realignments and interest rate changes.

However, looking further ahead, demographic factors should be strongly positive for the UK housing market, with large increases in the number of 25-34s – a key age group for first-time buyers – set to take place over the coming years. This should support housing demand over the longer-term. 

CML market forecasts - November 2009

Sources: CML research, HMRC, Bank of England 

Notes:
1. Transactions are based on HMRC series for UK residential transactions valued at £40,000 or over
2. June 2009 forecasts in brackets where applicable
3. Figures for arrears and possessions relate only to first charge mortgages held by lenders who are members of the CML.  They do not include arrears and possessions relating to other secured lending or to firms that are not CML members.

CML Research

1. Name: Paul Samter
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2. Name: Bob Pannell
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