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Published: 18 October 2012 | Author: Bob Pannell

  • Recent reports of a sharp recovery in real incomes are unlikely to ring true for most households, for whom the scope for discretionary spending is still likely to be modest.
  • The housing market has been fairly resilient, at subdued levels of activity, for some while. There have been signs of demand softening over recent months, but monthly patterns may have been distorted by the Olympics.
  • House purchase demand failed to lift significantly in the third quarter, despite much better mortgage availability.


Commentators have been somewhat more positive about UK economic developments in recent weeks.

The latest revisions suggest that GDP shrank by just 0.4% in the second quarter, down from the first estimate of a 0.7% fall. Stripping out the probable loss of activity as a result of the extra Jubilee bank holiday, it seems probable that the economy is broadly flat rather than contracting. This assessment is unlikely to change very much when strong growth for the third quarter is reported on the back of earlier distortions unwinding.

Labour market trends have also been surprisingly good, with the latest headline figures reporting a 50,000 fall in unemployed people in the three months to August. Employment rose by 212,000 over the same period, including a 90,000 improvement in full-time employment.

We have also seen two successive quarters of reported increases in real incomes, with the Office for National Statistics recently announcing that real incomes rose by 1.6% in the second quarter.

This may seem a little odd at first sight.

While the gap between wage growth and consumer price inflation has narrowed significantly over the past year, current earnings growth of 1.6% per annum still trails behind the latest CPI figure of 2.2% (September).

Chart 1: Earnings and inflation, % change year on year

Market commentary October 2012 earnings

Looking at the detail behind the headline figure, the main contribution to actual incomes came from growth in social benefits – broadly speaking state benefits and the imputed value of public services such as health and education. This will be boosted significantly by the one-off uprating of the basic state pension and working age benefits by 5.2% from April 2012 in line with last September’s CPI inflation number.

The other substantial positive contribution to incomes stems primarily from the higher levels of employment referred to earlier. While this should be good for consumer sentiment and the housing market, the benefit is likely to be diluted - perhaps significantly so - by the limited nature of individual pay rises and upward price pressure on essential items. 

Recent indicators suggest that the position of households has not changed materially over recent months, with household confidence levels continuing to be pretty subdued.

With the latest MPC minutes noting that inflationary pressures might pick up again later this year on the back of anticipated rises in food and fuel bills, we may not see a durable recovery in housing market sentiment until well into next year.

Housing and mortgage markets

The latest Bank of England figures present a rather flat picture overall.

Gross lending was 1% higher at £12.9 billion in August, but was 2% lower than a year ago. August is traditionally one of the strongest months for lending in the year, and stripping out this seasonal pattern, the underlying trend in activity has been weaker for several months.

But, as our latest Regulated Mortgage Survey illustrates, weak remortgage activity has been a key part of the narrative for much of the past year. The value of remortgage lending in the three months to August was 24% lower than a year ago, whereas house purchase lending was 6% higher.

According to HMRC, housing transactions totalled  93,000 in August – the strongest monthly outturn for nearly three years.

But it now appears that some of this buoyancy reflected distortions associated with the Olympics.

Our forward estimate is that total gross lending was £11.6 billion in September – a disappointingly lacklustre outturn that would have been 10% lower than August and 15% less than a year ago. Much of the reduction appears to reflect weaker house purchase activity compared with August. This ties in with the weaker house purchase approvals data reported by the Bank of England for the past three months.

Chart 2: Loans for house purchase

Market commentary October 2012 hp

Source: Regulated Mortgage Survey

This provides an uncertain backdrop for gauging the probable impact of the government’s funding for lending scheme (FLS).

As the latest MPC minutes note, banks’ funding costs have fallen significantly over recent weeks, and at least some of this is likely to reflect the impacts of the FLS initiative and the Extended Collateral Term Repo facility. Some mortgage rates have been reduced since FLS was launched. And lenders responding to the latest credit conditions survey expect the FLS to drive further improvements in mortgage availability this quarter, over and above that seen in Q3.

UK regulators have also sought to ensure that the microprudential framework does not counteract the actions taken to encourage lending, with the FSA adjusting the liquidity and capital regimes for UK banks and building societies.

While the policy intention is clear, senior policy-makers recognise that market realities represent significant headwinds.  For example, MPC member Paul Fisher  recognises that some firms may still need to deleverage, noting that “…we cannot expect every bank in the FLS to increase its stock of lending to the real economy over the 18-month period. It is to be expected that some firms still show an overall reduction, even if the FLS is successful. The crucial impact will be whether the FLS enables them to lend more than they would have done in its absence”. He has also cautioned against expecting instant success.

Measured optimism seems sensible. While the third quarter saw the biggest increase in mortgage availability since the credit conditions survey began in 2007, especially for higher LTV borrowing (more than 75%) which might be expected to particularly benefit first-time buyers, lenders reported a weak response in terms of stronger house purchase demand.

The tighter mortgage pricing that FLS enables will help some borrowers at the margin, but the big question over the coming months will be the extent to which a greater availability of funds attracts greater demand, and in what parts of the market.