Market commentary

Mortgage arrears improving

It is over a year since official interest rates were cut to the current historic low, and many mortgage borrowers continue to benefit. The CML's first quarter mortgage arrears and possessions figures show a steady decline in the number who have fallen behind since the second quarter of last year, and the number of possession cases has also declined. This is a far better outcome than we, and many other commentators, had feared as we went into the sharpest recession in living memory.

With interest rates likely to remain low for some time yet, we look to have avoided the spike in arrears and possessions seen in the early 1990s. Along with lower monthly repayments and a smaller increase in unemployment than had been feared, lenders have worked with borrowers to overcome short-term difficulties and keep them in their homes. However, we are not out of the woods yet. While our initial forecast for possessions to reach 53,000 this year looks pessimistic, there are still considerable risks to the outlook.   

Spending cuts in the pipeline...

The new coalition government has further focused attention on the state of the public finances, with the early signs that it is keen to take action sooner rather than later. Events across southern Europe have shown the potential danger of postponing difficult decisions. The new administration has already committed to cut public spending with £6 billion of efficiency savings this year. Some details will be announced next week, and we should have a clearer picture of the fiscal outlook after the emergency Budget on 22 June.

But one measure that has been announced is the creation of an Office for Budgetary Responsibility. This independent body will publish forecasts for the economy and public finances, which have previously been signed off by the Chancellor. The Office will judge whether government policy is consistent with meeting deficit reduction objectives. It will remove the temptation to paint too rosy a picture of the future path of the public finances through overly-optimistic growth forecasts.

It is clear that a combination of spending cuts and/or tax rises will take place over the coming years. The government has said that the bulk of the deficit reduction will be from lower spending, although many independent commentators believe there will be some tax rises, including an increase in VAT.

...which will limit the speed of recovery...

The economic backdrop is improving, and there appears little imminent prospect of slipping back into recession. The first quarter growth estimate of 0.2% is likely to be revised up, particularly with subsequent data showing accelerating growth in the manufacturing sector. But looking further out, the need to address the public finances will inevitably have an impact on the economy at large. And, at the same time, the financial sector is still in the process of restructuring balance sheets so access to credit is likely to remain restricted.

This creates a rather weak environment for the housing and mortgage markets. Despite the fall in activity following the end of the stamp duty holiday at the turn of year, the current underlying position looks relatively stable. The usual seasonal pick up in March was followed by a predictable drop in April, not least due to the Easter break. We estimate that gross lending totalled £10.2 billion in April, almost unchanged from a year earlier and consistent with little underlying change.

There have been further signs of increased mortgage availability in recent months, a few more higher LTV products coming onto the market and rates falling slightly. This should be modestly positive for activity. As should the abolition of home information packs, which will marginally reduce transaction costs. But it remains a difficult market, particularly for first-time buyers who do not have a large deposit. Lenders continue to face funding challenges. The prospect of various official support schemes ending from next year, and the need to refinance the assets currently parked with these programmes, still hovers over the market. Credit availability is likely to remain restricted for some time.

... so the outlook is for more of the same

So there is little reason to expect much underlying change in the housing and mortgage markets. The gradual improvement is likely to be slow with the economy and the financial sector still facing a number of headwinds.

On a positive note, action on the fiscal position should reduce pressure on the Bank of England to raise interest rates. Mervyn King signalled his approval of the plans he has seen, and the Bank is likely to take a more relaxed view on inflation if it is convinced the government is addressing the deficit. The high April CPI reading shows this risk has not entirely disappeared, with inflation at an eighteen year high of 3.7%, well above the 2% target. But inflation is expected to dissipate over the coming months. 

The UK is likely to see housing costs included in the target measure in the future. The Chancellor has asked the Governor for his view on how this might be implemented. If this change is made, we will likely see a new rate being set, as happened when the measure changed from RPIX to CPI and the target rate was reduced from 2.5% to 2%.

The longer rates remain low, the longer those borrowers potentially facing difficulties have to recover. However, the number of borrowers in the deepest arrears categories has not come down as sharply as for shorter term cases. They are less likely to be able to repair their situation and this means possession rates are unlikely to fall sharply from current levels in the immediate future. 

CML Research

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