Market commentary and forecasts December 2011
Published: 15 December 2011 | Author: Bob Pannell
- Short-term economic prospects, and so the outlook for the housing and mortgage markets, are challenging and highly uncertain.
- The future pricing and availability of UK residential mortgages is closely tied to wholesale funding developments, and so in turn relates to how effectively the Eurozone deals with its sovereign debt problems. Our central forecast assumes that there will be a resolution, but this leaves considerable upside and downside risks.
- Our central view is that housing transactions and mortgage lending activity will be broadly flat next year, continuing the subdued pattern of the past few years. Consumer confidence is currently at a low ebb, which suggests that borrower appetite may be muted – particularly for house purchase - at least until real incomes show signs of stabilising.
- Recent government housing initiatives should help to boost the proportion of house purchases made by first-time buyers, but their overall market impact depends upon ongoing mortgage credit availability.
- The household sector has been under financial pressure for some time, as a result of falling real incomes, and more recently higher unemployment. This is likely to unwind some of the improvement in mortgage arrears we have seen over the past two years and lead to a somewhat higher level of possessions in 2012.
Our turn-of-the-year market forecasts are being published when there is an unusual degree of uncertainty about short-term prospects.
Economic recovery in the UK has been weak and patchy, and a notable feature so far has been the conspicuous absence of consumers. As the Office for Budget Responsibility (OBR) recognised in its most recent Economic & Fiscal Outlook, the household sector has been under financial pressure for some time, as a result of falling real incomes, and this has fed through into subdued levels of consumer spending, low consumer confidence and limited borrower appetite.
While such pressures should begin to ease through 2012 as inflationary pressures recede, there is uncertainty about how quickly this may happen and whether it will prompt households to lift their spending or borrowing on a significant scale. The perceived need for discretionary savings could fall away quickly when households see inflationary pressures easing, although the protracted nature of the income squeeze that has been endured suggests that this may be only an outside chance.
The global economic and financial situation has deteriorated sharply over recent months, and this adds a further layer of complexity. The ongoing Eurozone crisis in particular casts a veil over what the future holds.
Were the Eurozone to implode, this would have wide-ranging adverse consequences across major economies, from which the UK would not be immune. Thankfully, our financial firms are relatively well-placed to weather any storm and the UK authorities well-placed to mitigate the worst impacts of a renewed credit crunch, but we would in such circumstances still experience a marked contraction in lending activity. However, the continuation of ultra-low interest rates and the willingness of the Bank of England to undertake fresh QE would help to guard against escalating mortgage debt-service problems and significant house price falls, in all but the most extreme scenarios.
While the risks of Eurozone implosion have risen in the past few months, and can no longer be viewed as negligible, there are signs that national governments and supra-national authorities are aligning on the need for fiscal and economic reform, and the reform of European institutions. The path to such reforms is unlikely to be a straight one, but our central view remains that European policy-makers will stabilise sovereign debt problems such that the current stresses in financial markets do then progressively ease. A similar assumption underpins the Bank of England’s latest projections and those from the OBR.
Recent euro difficulties have caused near-term growth prospects in the euro area to evaporate, so narrowing the odds of a double dip recession here in the UK. Whether or not this happens, the current pace of economic expansion is anaemic, with the OBR and many other commentators pencilling in sub-1% economic growth for the UK next year.
The prospect of much weaker economic growth in the UK makes fiscal policy more challenging. In his autumn statement, the Chancellor announced a variety of measures to help bolster the economy over the short-term, including an ambitious plan for credit easing, to improve the flow of credit to smaller firms, and levering in private sector funds to help fund infrastructure projects, but there are few details as yet. While the OBR confirms that the Chancellor is adhering to the government’s deficit reduction plans, there is now a much higher profile for government borrowing and debt over the medium term than envisaged at the time of the March 2011 Budget.
As far as supporting the economy, the government continues to rely on monetary policy to do much of the heavy lifting – the Chancellor’s latest open letter to Mervyn King, Governor of the Bank of England, refers to monetary policy's “critical role in supporting the economy”. The MPC undertook some pre-emptive monetary easing in the form of QE2 in October, and November’s Inflation Report and the comments of individual MPC members indicate a readiness to embark on further QE if necessary. Short-term interest rates now look set to remain at historically low levels for much longer than expected, with positive ramifications for ongoing mortgage affordability.
Table 1: CML market forecasts
Source: Bank of England, National Statistics, HM Revenue and Customes, CML
1. Transactions are based on Her Majesty's Revenue and Customs' series
for UK residential transactions valued at £40,000 or over. These include cash-based sales that have comprised roughly a third of transactions in recent years.
2. Figures for arrears and possessions relate only to first charge mortgages.
Housing and mortgage markets
The wider economic picture represents a challenging backdrop for the UK housing and mortgage markets.
Mortgage lending activity has been pretty flat for some while. Recent credit conditions surveys indicate that the weakness has become more demand-led, reflecting the difficult state of household finances and wider economic uncertainty.
Prior to the summer, wholesale funding conditions were getting easier and UK banks had made significant headway in repaying the original £185 billion worth of liquidity provided under the Bank’s Special Liquidity Scheme. An improvement in credit availability saw a larger number of active mortgage lenders, greater competition for lower LTV business and a modestly growing risk appetite.
Despite these positive developments, housing market activity has remained lacklustre. This largely reflects those economic factors suppressing household confidence.
But it is also a consequence of existing borrowers having greater discretion over the nature and timing of property sales. Nowadays, when home-owners wish or need to move house, they have the option of renting out their current property (and themselves renting another elsewhere), rather than having to sell, regardless of market conditions. Those inheriting properties from elderly relatives may also feel able to rent it out for a period rather than opt for an immediate sale. Today’s low interest rates also mean that households facing payment difficulties have much longer time horizons over which to repair their finances or make alternative arrangements.
Such factors are likely to result in fewer forced sales, and so limit the downwards pressure on house prices. As a consequence, weaker demand initially tends to show through in lower property sales. If and when house prices do weaken, as they have in some parts of the country, this adversely affects the housing equity position of existing owners. This risks exacerbating any funding constraints those looking to move home would face, shrinking demand and once again bearing down on transaction volumes.
The bottom line is that we currently have a housing market which has an in-built bias towards low volumes of transactions.
Chart 1: House purchase and remortgage loans, 12-month moving totals, 000s
Source: CML, Regulated Mortgage Survey
While there has been a pick-up in buyer activity over recent months, housing transactions for 2011 as a whole will be broadly comparable with the subdued levels of the past three years. Looking further ahead, activity levels could weaken a little bit further, at least until such time as households become more confident about the wider economic situation and their own personal finances.
Remortgage demand has had a somewhat more resilient tone. Activity levels have been above year-earlier levels for some time, but (as for house purchase) materially lower than before the credit crunch.
Despite a large number of borrowers migrating to variable rates when their mortgage deals expired, overall remortgaging numbers have been held in check by continuing very low short-term interest rates. As lending criteria and pricing have become more competitive, the incentives for some borrowers with reasonable equity levels to switch providers have grown. The effect is a modest one, but may be temporarily accentuated over the near-term, as Eurozone uncertainties encourage borrowers to take out deals while they are still seen to be available.
In contrast to home-owner loans, there has been a relatively strong pick-up in buy-to-let lending over the past few quarters.
To date, much of this has been related to remortgaging activity, but house purchase activity by landlords has also strengthened. As a recent News & Views article explained, some of this is a bounce-back from very sharp falls in the aftermath of the credit crunch. But the combination of strong demographics, limited new-build and the affordability pressures facing potential home-buyers has resulted in strong rental demand and upward pressure on rents. While this is likely to self-moderate in due course, it provides a strong platform for buy-to-let activity to continue growing in the foreseeable future.
Chart 2: Buy-to-let lending activity
The government’s recent housing strategy featured measures to support the housing market, including a new-build indemnity scheme to increase the supply of mortgage finance for new build homes and a reinvigorated Right-to-Buy policy encompassing a commitment to replace sales with new build on a one for one basis. The government has not attached specific targets to these initiatives, but it sees both as providing important stimuli for the beleaguered house-building sector. Clearly, both provide some valuable upside potential for transactions and mortgage lending too next year. But with scheme details still to be worked out, we are unlikely to see full-year impacts in 2012, and so the benefits are initially likely to be incremental rather than transformative in nature.
In prioritising the measures announced in its housing strategy, the government has decided that the current stamp duty concession for first-time buyers will end next March. While we share the government’s view that the concession has had little demonstrable impact on demand, its removal will distort the monthly pattern of transactions and risks undermining fragile market sentiment.
More crucially, however, the government’s package of measures is somewhat hostage to future funding developments.
Reflecting the knock-on effects from the Eurozone difficulties, firms’ access to wholesale funding markets deteriorated markedly from the summer. Long-term unsecured wholesale markets remain effectively closed. While UK banks are currently still able to raise funds using secured lending routes – including through issues of mortgage-backed securities and covered bonds - these cannot satisfy all funding needs. Competition for retail savings has become even more intense, causing the cost of retail funding to spike in recent months.
Looking ahead, as the Bank of England has noted, if Eurozone problems persist, the gradual improvement we have seen in risk appetite and the pricing and availability of mortgages in the UK might well go into reverse. Even a resolution could entail a significant pause before we see renewed improvements in the pricing and availability of mortgages.
Arrears & possessions
Despite the current economic picture being difficult, we have seen further lessening in reported mortgage payment difficulties through 2011. According to our quarterly figures, the number of mortgages with arrears that were at least 2.5% of the mortgage balance has now fallen continuously for the past two years. This is a better outturn than we had expected, and reflects both the limited nature of job losses (until very recently) and the greater scope for borrowers to deploy coping strategies as a result of interest rates staying at very low levels.
Some of our earlier pessimism stemmed from the emphasis we gave to the likely cumulative pressure on household finances from the higher cost of living and modest growth in incomes. But this appears only now to be emerging as a driver of fresh arrears.
Over recent months, as fiscal cuts have begun to be felt, the UK has seen a sharp increase in headline unemployment figures, and the OBR envisages a higher level of joblessness persisting through next year and beyond. With higher unemployment and a prospect of real incomes stabilising at best over the course of the year, we should expect to see increased signs of financial stress.
We foresee a deterioration in the number of borrowers behind on their mortgages and a more difficult and protracted period of adjustment for households seeking to re-order their finances. But, as can be seen from Chart 3, the benign impact of low interest rates has weakened the link between job loss and mortgage arrears – arrears will continue to be materially lower than in the mid 1990s, when unemployment was last at comparable levels, and the forecast deterioration through next year would not even return arrears to the highs seen as recently as 2009.
Chart 3: Mortgage arrears and unemployment
Source: CML, Office for National Statistics
Note: Dashed line shows OBR forecasts for unemployment
While lenders will continue to work with borrowers, debt advice agencies and government to minimise the impact of serious arrears cases, those borrowers in arrears whose situation does not improve will be vulnerable to possession. We foresee some increase in the number of possessions next year.
The weak state of the wider economy and household finances creates a challenging and highly uncertain backdrop for the housing and mortgage markets.
Despite the fact that activity levels have already been subdued for several years, we have pencilled in a broadly flat picture – for both mortgage lending and property transactions - at least until real incomes show signs of stabilising as inflationary pressures recede.
As a by-product of sovereign debt worries, lenders face challenging conditions in wholesale funding markets, and these could have negative effects on the cost and availability of UK residential mortgages through some or all of next year.
But, if European leaders navigate a comprehensive and sustainable way through Eurozone problems, current financial market stresses could heal - and the previous pattern of gradual improvement in cost and availability of funds re-emerge - relatively quickly. This in turn could have a major benefit on UK growth prospects, and boost household confidence and appetite to borrow.
Recent government initiatives should help to modestly boost the proportion of house purchases made by first-time buyers, but their overall market impact depends upon mortgage credit availability.
The prospect for higher unemployment and some further income squeeze suggest that mortgage payment difficulties may get worse, but not dramatically so, given the continued shielding that low interest rates provide.
We noted at the start of this paper the unusual degree of uncertainty that surrounds short-term prospects. Our central forecasts are subject to a range of upside and downside risks, with the biggest relating to activity levels and mostly in a downwards direction. We will monitor economic and financial market developments closely, and revise our market forecasts as events become clearer.