Market commentary

There has certainly been a rather gloomy mood around UK economy recently. The OECD and IMF both downgraded their forecasts for growth for here and much of continental Europe. And the housing and mortgage markets are not immune. A recent PricewaterhouseCoopers report described the market as vulnerable to further set backs and does not expect much change in real (inflation adjusted) prices over the next decade. Meanwhile, ratings agency Moody's warned of a number of challenges facing lenders over the years ahead, including uncertainty over the economy and house prices and a tougher regulatory backdrop.

Despite some modestly positive signals in recent weeks, including a fall in the number out of work, there are still several factors causing uncertainty and clouding the outlook.  

An austere budget should allow monetary policy to remain supportive

As had been well trailed, the Chancellor unveiled an austere Budget to put the public finances back onto a sustainable trajectory. It is still not clear exactly where the sizeable public sector spending cuts will fall. The spending review will be published on 20 October. But a leaked memo from the Office for Budget Responsibility suggested the public sector workforce could be reduced by almost half a million in the coming years. However, unemployment is still forecast to fall over the rest of this parliamentary term, from the current 7.8% to 6.1% in 2015. So the recovery is highly dependent on the private sector picking up the slack. The OBR believes the economy will return to stronger growth from next year and the underlying deficit will be eliminated by 2014-15. But the need to tackle the public finances creates considerable uncertainty.

The Bank of England has welcomed the plans and this should help extend the period over which interest rates can remain low - a factor that has supported the housing market and reduced monthly mortgage bills for many borrowers. But we have seen the first sign of dissent on the MPC, with Andrew Sentance voting for a rate rise at the June meeting. Mr Sentance has stressed that he only sees a need for a very gradual rise in rates to counter signs of higher inflation. Most commentators expect that tightening on the fiscal side will reduce inflationary pressures in the economy at large, and the Bank's own projections back this up. So there is little prospect of any change in rates in the short-term. But, although inflation has fallen a little recently, it has remained stubbornly above target and does present a risk to this outlook.

There was some positive news for the housing market in the Budget. Capital gains tax was increased to 28% for higher rate taxpayers, a rather smaller increase than had been trailed. The change was brought in instantly, meaning there is little incentive for investors or second home owners to sell in reaction to the change. We see this having little overall impact. For many buy-to-let investors, low interest rates are resulting in strong cash flow returns and there is little reason to sell and exit the market.

Mortgage Market Review points to more difficult access to credit

Publication of the FSA's mortgage market review consultation paper on responsible lending pointed to a period of tighter credit control and the difficulty some could face when trying to access mortgage finance in the years ahead. The CML has pointed out the potential impact on consumers from the effective banning of income non-verified mortgages and tighter controls around interest-only mortgages. While lenders already use their own methods to assess affordability, the FSA's plans to make borrowing safer could make it harder for some households to access the market and meet their aspirations of home ownership.

Together with more cautious regulatory requirements around how firms are funded, including financing through more long term (typically more expensive) assets, the cost of mortgage finance could increase in the coming years.

The short-term outlook is for little change

The short-term outlook is also rather subdued. Our gross lending estimate of £13.1 billion in June did represent a seasonal pick-up, and is up on a weak June last year, but is still indicative of low levels of activity. Housing market turnover remains low and is unlikely to pick up much with still weak consumer confidence and households' disposable incomes under pressure. VAT will rise to 20% early next year and income tax thresholds have been frozen. There are anecdotal signs that the rise in house prices over the last year has tailed off, and estate agents now expect a modest slide in prices over the coming months. 

Some commentators have cited an increase in the number of properties on the market as a reason for price pressures easing. Much of this could be down to the abolition of home information packs, which has reduced the cost of marketing property. It should add a little more liquidity into the market.

There is little sign of more credit coming into the market. The second quarter credit conditions survey from the Bank showed that lenders expect a modest reduction in the amount being made available in the coming months, and for demand to remain constrained as well. The industry still faces the prospect of refinancing wholesale assets, both those currently held under official support schemes (which start to expire next year) and in the markets. The Bank has said that the industry is developing plans to address this, but raised concern on whether firms will be able to raise sufficient retail deposits at the same time.

So a period of uncertainty looms. There are some positive signs, not least with the labour market having held up so far, early signs of economic recovery and more property coming onto the market should support activity to some degree. But we do not know how many of the unknowns will be resolved. The longer-term outlook is for a subdued economy and housing market for some time. And in the short-term we could see further bouts of weakness.

CML Research

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