CML news & views
Issue no. 17 - 11 September 2013
Too soon to call a boom - so where are we in the housing cycle?
Mark Carney’s first speech as Governor of the Bank of England led to widespread media speculation about how, when and in what circumstances the Bank might intervene to dampen activity in the housing market. A key part of the Governor’s speech at the end of last month focused on how the Bank could persist with a low interest rate policy to help secure broader economic recovery, while using other tools to control risks in sectors like housing that might show signs of unsustainable future buoyancy.
As our chief economist Bob Pannell pointed out in a recent CML blog, we are a long way from such conditions and we do not imagine that Bank officials are losing sleep about current developments in the housing market. As the blog said, the pace of housing activity is moderate, and affordability metrics are unexceptional. But the recent pick-up in housing market activity, following a long period of sluggishness, has raised questions about where we are in the housing market cycle. In this article, we look at recent developments and compare the current improvement in conditions with the prolonged recovery from the last housing market downturn in the early 1990s.
The governor's toolkit
In his first major speech as Governor, Mr Carney acknowledged that the combination of a recovering banking sector, low interest rates and government initiatives could provoke concern that seeds were being sown for a new cycle in the housing market. But he reassured a business audience in the east midlands that the Bank was monitoring developments closely and remained "acutely aware of the risk of unsustainable credit and house price growth."
The Governor emphasised that a range of tools other than interest rates could be deployed to contain risks in the property and financial sectors. This expanded macro-prudential toolkit had not been available prior to the crisis, he said, and the Bank was fully prepared to make use of it if required. Among the measures available, the Governor referred specifically in his speech to:
- more intensive supervision of lending to specific sectors;
- the ability to recommend that banks and building societies restrict the terms on which new credit is made available; and
- the ability to raise capital requirements on mortgage credit – or any other type of lending.
Mr Carney told his audience: "Having these in our toolkit, and if necessary using them, will help us to keep interest rates low to secure recovery without creating risks that make recovery look unsustainable." He continued: "In short, we are providing the stimulus the economy needs, but in a disciplined way to secure price and financial stability."
Housing markets conditions across the UK
Mr Carney delivered his speech on the day we published data on lending in Scotland, Wales, Northern Ireland and London. Our figures showed that in each of these very different housing markets there had been a significant increase in activity, although the rate of growth in each varied. Each of these markets also showed different measures of affordability for buyers, and other distinctive characteristics.
The media juxtaposition of Mr Carney’s speech alongside the London data in particular attracted considerable media comment – with some coverage highlighting that the average deposit paid by first-time buyers in the capital had risen to £64,000, and was based on an average household income of £52,000.
Alongside the similarities in terms of the recent upturn, there are other significant differences between the property market in London and the rest of the UK. Rates of home-ownership in the capital are lower than elsewhere in the country, with less than half of London’s population in owner-occupation. Property prices and incomes in the capital, meanwhile, are significantly higher than the UK average.
London is also unique in the UK as a global city, with parts of the capital attracting a considerable number of international property investors. London remains a large and influential housing and mortgage market but, within the capital, there are huge differences in house prices, affordability and local market conditions.
Despite affordability pressures in the capital and lower levels of owner-occupation, the London property market continues to dwarf the national markets of Scotland, Wales and Northern Ireland combined. In the second quarter, lenders advanced more than 20,000 loans for house purchase in London, worth more than £5 billion – compared to £1.74 billion in Scotland, £680 million in Wales and £210 million in Northern Ireland.
Media pre-occupation with buoyancy of the London property market persists, but our data showed that lending for house purchase in Scotland, for example, was growing in the second quarter at twice the rate of the capital. The value of house purchase loans in Scotland in the second quarter was 55% higher than in the preceding three months, compared with growth of 23% in London.
What our data really shows is that the “UK property market” is actually a complex and dynamic patchwork of regional and local conditions in different locations across the UK. It is crucial for policymakers to understand and reflect the complexity of different, but inter-linked, market conditions. So, while policymakers may have an enlarged toolkit to apply to the housing market, intervention to dampen buoyancy in some locations would almost certainly bear down on other local markets where activity is more subdued – unless carefully targeted.
Where are we in the housing cycle?
Although experience in local markets across the UK is varied, there are signs of a general recovery in activity following a long period of stagnation. Our data showed that lending in June and July was 27% higher than a year previously. But earlier in the spring year-on-year comparisons of lending volumes were broadly flat.
House prices have also edged upwards during the summer, according to both the Nationwide and Halifax indices (in August, up year-on-year by 3.5% and 5.4% respectively). But, like the recovery in lending, the growth in house prices is only a recent phenomenon. Both indices showed that, earlier in the year, prices were broadly the same as 12 months earlier.
Data shows that activity in the current cycle is following a pattern remarkably similar to the early 1990s, when signs of recovery took several years to emerge. Then, as now, nominal house prices and the volume of transactions stabilised at a significantly lower level for a three- or four-year period before slowly recovering (see Charts One and Three). Chart Two shows that, in both the current cycle and the last one, real house prices continued to decline for up to five years from their peak.
Chart One: Nominal house prices, % fall from peak
Chart Two: Real house prices, % fall from peak
Chart Three: UK transactions, % fall from house price peak
Perhaps the most significant difference between then and now is that, in the first two years of the more recent market correction, the initial decline in the volume of transactions and both nominal and real house prices was much more pronounced. But, from around three years after the peak in both cycles, the pattern of activity in house prices and transactions volumes has been remarkably similar.
In the 1990s, it eventually took more than eight years for nominal house prices to regain their previous peak. Real house prices did not return to former levels for more than 12 years, while property transactions never regained their former peak. As Chart Three shows, however, the decline in transactions in the current cycle has been even more pronounced than before, with current activity levels still significantly lower than in the last downturn. In the last five years, the number of house sales has averaged less than 900,000 annually, 60% below the average in the decade up to 2005.
Housing and mortgage markets have shown some initial signs of recovery this summer, but commentary suggesting this improvement is an incipient boom is premature. In his recent speech, the Governor made it clear that the Bank would continue to monitor carefully the effects of policy intervention but reminded his audience that recent developments in the housing market "must be kept in perspective."
The Governor continued: "Mortgage approvals are currently running at only a little more than half, and transactions a little more than two-thirds, of pre-crisis levels. Households’ debt-servicing costs relative to income are below their 20-year average, and houses cost the same relative to earnings as they did in 2003."
The UK economy should benefit from an expanded range of macro-prudential tools that potentially that enables policymakers to continue to foster economic recovery, while containing activity in sectors showing signs of excessive buoyancy. Data indicating improving conditions in the housing market have begun to emerge this summer, but we are only in the early stages. Comparisons of longer-term trends show that the current recovery is so far following a pattern broadly similar to the extended period of improvement that we saw in the last cycle.