Market commentary

A brighter year ahead... 

The mood surrounding the UK economy and housing market has certainly improved from a year ago. We look to have moved out of recession, with NIESR reporting that the economy grew over the last three months of 2009, although we will have to wait until next week for official confirmation. Meanwhile, we have seen more encouraging signs from the labour market in recent months.

And the year ahead looks rather brighter than last. While we await data from the end of the year, 2009 will have seen the lowest level of housing market activity in half a century of available figures. Meanwhile, lending volumes were also at their lowest levels for some time. Net lending, the growth of the outstanding UK mortgage book, is likely to have come in just above £10 bn for the year, which would be the lowest since records began over twenty years ago. However, reflecting the improvement over the second half of the year, both of these outcomes are considerably better than had been feared early in the year. The recent rise in reported house prices has also caught commentators by surprise.

We have also seen some modest recent improvement in the availability of mortgage credit. There has been a small increase in the range of mortgage products, including at above 75% loan-to-value, on the market. The Bank of England's quarterly Credit Conditions Survey suggests this will continue over the first quarter. Together with the gradually improving economic backdrop, there is reason to look to the year ahead with rather more optimism than was the case twelve months ago.

...but only a slow recovery expected...

However, the pace of the recovery, across the economy and housing market, is likely to be rather lacklustre. In common with much of Europe, the UK is only expected to see a relatively modest economic expansion this year - in contrast to a rather faster rebound in the US and especially Asia. Some commentators have talked about the UK's vulnerability to a double dip recession, with significant risks attached to the fiscal position and a still slow flow of credit to the wider economy. The longer-term outlook, while better, is also clouded. The Ernst & Young ITEM club last week pointed to a difficult "decade of adjustment" as banks and the government repay overseas debt. This process is expected to restrain borrowing and spending at home. It will have a significant impact on the housing market over the long-term. Many of these issues will be discussed at the CML's future of housing conference next month. 

The fiscal position continues to loom large over the recovery. The authorities face a difficult balancing act in common with several major economies, as was recently highlighted by both Mervyn King and the IMF. Taking steps to reduce the deficit too soon could choke off the recovery. But waiting too long could mean that the markets no longer trust that the position is credible, which might increase the cost to the government of financing the debt. As it stands, the markets look to have accepted that no concrete measures will be taken prior to an election - but more detailed plans to reduce the deficit will be needed in the next parliamentary term.

... with immediate prospects for monetary policy now in focus...

After the unprecedented policy response to the financial crisis over the last 18 months, the February monetary policy committee meeting could represent a key turning point. The Bank of England is widely expected to announce a pause in its asset purchase program (quantitative easing), which is due to complete the £200 billion currently scheduled in the coming weeks. It seems likely that the MPC will take some time to assess the impact of the policy and the state of the recovery before making its next move. 

However, MPC member Andrew Sentance has recently suggested that there is no certainty that interest rates will remain unchanged for the rest of the year. The potential for higher than anticipated inflation forcing the Bank to raise rates is a significant risk to our forecasts. If rates were materially increased this year it would have an adverse impact on the housing and mortgage markets. 

...and short-term conditions complicated by the end of the stamp duty holiday

The challenging backdrop means the prospects for the housing and mortgage market are fairly muted for the coming months. Activity, while at much higher levels than a year ago, remains slow on any historic comparison.

This means that the market is particularly sensitive to any change in the environment. The end of the stamp duty holiday for properties valued between £125,000 and £175,000 at the turn of the year is a prime example. Our December gross mortgage lending estimate, at £13.7 billion up from £12.1 billion in November, was higher than anticipated. The last month of the year usually sees a drop in activity. Anecdotal evidence suggests the rise was driven by a surge in house purchase completions - remortgaging volumes have remained extremely weak for some time. Completing transactions before the end of the year to beat the end of the stamp duty holiday is the most likely explanation. If there has been a "bunching" of sales to beat the rise, we could see a greater drop off in activity in the coming months than the usual seasonal fall.

And the uncertainty created by the forthcoming election, and the likely fiscal consolidation thereafter, means that there is unlikely to be a rapid improvement further out. In addition, lenders still face difficult funding conditions. While funding markets are much improved in recent weeks, there are large volumes of liabilities currently "parked" with the authorities under various liquidity support schemes. These schemes are due to expire from next year, and the need to refinance is likely to continue to restrict the flow of new credit to the wider economy.

But with a gradual pick up in economic growth, and providing interest rates remain at or near current lows for some time yet, there is every reason to a expect a gradual improvement over the latter part of the year. And certainly for a better year than last.

CML Research

1. Name: Caroline Purdey
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2. Name: Bob Pannell
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