Market commentary
18 June 2010
We do not expect the Budget to include housing and mortgage specific direct tax measures. But the market will inevitably be affected by how policy impacts on the wider economy - particularly on household finances and confidence. However, the possible increase in the capital gains tax rate could impact negatively on the buy-to-let market at a time when there has been some improvement in funding for the sector. Much depends on the detail and timing of any change.
Financial sector regulation is a further source of uncertainty. The Chancellor has announced that the Bank of England is to take on regulatory responsibility for the banking system. As well as regulating individual firms, the Bank will have "macro prudential" powers and be accountable for the stability of the system as a whole. But it is not yet clear what levers it will have at its disposal to do so.
The housing market itself remains subdued and is likely to remain so over the rest of the year. There is little sign of the tentative relaxation in criteria feeding through into activity. There have been signs that the abolition of home information packs has led to an increase in the supply of property coming onto the market. Prices look to be broadly stagnating as does buyer interest. The government has said that it continues to support the aspiration of home ownership. But there has been little on how to improve the funding situation.
Scene set for a tough Budget
The tone from the coalition government has been clear on the need to start tackling the fiscal deficit immediately. Around £6 billion of spending cuts have already been announced and we will see more details of this in next week's Budget. But structural cuts in departmental budgets are unlikely before the conclusion of the spending review in the autumn. There is now a consensus across European governments on the need to reduce their deficits. Spain has announced an austerity package of €15 billion this year, Italy €24 billion over the next three years and even Germany is to reduce spending by €11 billion this year and €80 billion by 2014.
The Prime Minister has said the impact of the decisions made in the UK will "stay with us for years, perhaps decades, to come". But, while the newly created Office for Budget Responsibility has said that the economy will grow a little slower than projected in the Budget announced by the previous government, it does not believe the public finances are in a materially worse state than was set out then. The OBR will independently assess whether the Budget measures announced next week are consistent with the stated fiscal goals.
At the moment, most commentators expect the austerity measures, allied to the already gradual nature of the recovery, to allow the Bank of England to keep interest rates low for some time. However, while the latest reading showed an improvement, inflation has remained stubbornly high for longer than expected. There have been signs that some members of the MPC are becoming a little more hawkish. While the Bank does expect it to fall back to below the target rate, this does present a risk to the Bank's willingness to keep rates at or near current lows for an extended period.
Largely an indirect impact on the housing market
We do not expect direct tax measures in the Budget to affect the housing and mortgage markets, although there will be clarification of how the already announced cuts will impact on the social housing sector. The secretary of state for communities and local government has pledged to assess the effectiveness of the mortgage safety net to judge whether it offers the best deal for struggling homeowners and the best value for the taxpayer. The coalition has also said it will assess the effectiveness of the increased stamp duty exemption for first-time buyers, although this is likely to be a longer-term issue.
But, clearly the impact on household finances and confidence will be important for the market and the wider economy.
A change in the capital gain tax regime has been trailed, although firm details are yet to appear. It is generally expected that CGT will move from a flat 18% tax to an individual's marginal rate of income tax. While main residences will remain exempt from CGT, it could impact on the housing market through rental properties and second homes. If an increase in tax liability is to be brought in at a later date, there could be an incentive for landlords and second home owners to crystallise a gain before any change is implemented. And, going forward, a higher tax liability reduces the profitability of investing - coming at a time when we had started to see a tentative improvement in the flow of funds coming into the buy-to-let sector. But much will depend on what relief is available through tapers. While landlords who purchased in recent years are unlikely to be sitting on significant capital gains given the fall in prices over the 18 months to the early part of last year. At the same time, low interest rates mean that some landlords will be enjoying strong cash flow returns and have little reason to sell.
With other policies and developments at play
The market itself remains quiet, with some indication that uncertainty over the election and a dawning realisation of the spending cuts to come have weighed on buyer interest. There is no sign yet that the modest relaxation in criteria seen in mortgage terms has fed through into actual lending. Average loan-to-value ratios for first-time buyers has not changed in eighteen months. Our own estimate for lending in May shows a still very subdued picture, and the risk is that gross lending will marginally undershoot our forecast of £150 billion for 2010. While the indicators are somewhat mixed, price growth has eased in recent months and there are signs of more property coming onto the market since the new administration abolished home information packs.
Chart 1: House purchase activity remains subdued
Source: Bank of England
Looking further ahead, the new housing minister, Grant Shapps, has said that the government supports the aspiration of home ownership, arguing that it is wrong to deny the benefits of home ownership to the next generation. But, as he acknowledged, many commentators expect the home ownership rate to fall in the coming years. The funding position is likely to remain challenging for the industry for some time with the unwinding of support schemes to start next year. And on the housing supply side, builders have reported that uncertainty over the coalition's shift to "localism" has led to a seizing up of the planning system, which is likely to exacerbate the lack of supply going forward.
While we now know that the Financial Services Authority will be disbanded, there is still little hard information over how the financial system will be regulated. The Chancellor has announced that he will hand regulatory responsibility to the Bank of England. This includes monitoring the health of individual firms (although how firms deal with customers will fall under a new Consumer Protection and Markets Authority's remit) and the strength of the system as a whole. There has been some press speculation that this "macro prudential" role may include limiting at what loan-to-value ratio some firms can lend. But, beyond the Governor hinting at varying core capital requirements over the economic cycle, there has been no detail yet on what tools the Bank will be given to achieve industry-wide financial stability. The changes will be completed in 2012.
Overall, the prospects are for the market to remain subdued over the rest of the year, with activity at very low levels. The gradual recovery in the economy and the stamp-duty exemption for some first-time buyers will be modestly positive. But the Budget could be tougher than some expect, with the potential to unnerve an already fragile housing market.
CML Research
- Name: Caroline Purdey
Email: - Name: Bob Pannell
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