Published: 29 July 2014 | Author: Bernard Clarke
- Mortgage lending this year and next looks set to be stronger than we had projected. We expect gross lending this year to rise above £200 billion, for the first time since 2008.
- Affordability pressures, reinforced by the prospect of higher interest rates and the new regulatory environment for mortgages, may nudge housing market activity lower through 2015. But we now expect housing transactions this year and next to be higher than we predicted at the end of last year.
- Several years of improving arrears and possessions may be coming to an end, as a gentle but steady climb in interest rates over our forecast period adds to the financial pressures facing some households. Nonetheless, we now expect arrears and possessions to be lower in 2014 and 2015 than we said at the end of last year.
- Economic growth continues to underpin housing market sentiment and demand.
CML market view, July 2014
Strong economic fundamentals have continued to underpin housing market sentiment and activity, since we published market forecasts in late 2013.
Economic growth, supported by a recovery of business investment as well as stronger consumer demand, should be about 3% this year and 2.5% through 2015.
The UK has a record number of people – 30.5 million – in work, and the headline unemployment rate has shrunk to 6.6%, down from 7.8% a year earlier.
Short-term inflationary pressures are largely absent. Earnings growth remains subdued, with pay less than 1% higher than a year ago. This falls short of headline consumer price inflation, which is currently only a little below its 2% target.
Better mortgage credit availability has supported the recovery of mortgage demand over the past two years. However, the latest Credit Conditions Survey suggests that this source of stimulus may now be drying up, amid signs that lenders may be approaching the limits of their risk appetite with respect to maximum loan-to-value (LTV) and income multiples.
Our view last December, that the factors shaping mortgage pricing were becoming less favourable, appears to have been borne out by recent developments.
Chart One: Mortgage pricing, two- and five-year fixed rate
The latest Trends in Lending from the Bank of England notes that the pricing of new loans was little changed in the three months to May. The pricing of fixed-rate mortgages has increased, however, as interest rate expectations and swap rates have responded to Bank governor Mark Carney’s comments in his June Mansion House speech, that rate rises could come sooner than markets had been anticipating.
Whereas May’s Inflation Report had assumed that base rates will have increased to about 1.25% by the end of 2015, forward markets have now factored in another 0.25%. Even though the authorities clearly wish to keep interest rate rises within modest bounds over the coming years, any return to more normal levels will dilute one of the key ingredients that has revived the housing market.
For some time, we have been less optimistic than public bodies, such as the Office for Budget Responsibility and the Bank of England, that housing market activity will progressively return to longer-term norms of 1.4 - 1.5 million or so transactions annually (on the HM Revenue & Customs [HMRC] measure).
Chart Two: UK residential property transactions
While there has been a strong year-on-year recovery this year, we are mindful that house prices were already elevated relative to earnings when the current revival took hold. With house price inflation outstripping income growth across large parts of the country, and interest rises in prospect, it seems feasible that household demand may start to fade as affordability pressures intensify.
We do not see this happening to any great extent this year, although recent developments are certainly consistent with the London market being fully valued.
Implementation of the mortgage market review (MMR) in April has temporarily distorted a number of indicators of activity over recent months. As the associated "statistical fog" lifts over the coming months, we share the Bank of England’s view (expressed in its latest Financial Stability Report) that underlying levels of demand will emerge looking pretty robust over the short term. The HMRC transactions figures for June support this.
But while housing demand is still evident, housing market transactions are also a function of new-build volumes and overall market liquidity.
While there may be some further pick-up in construction activity, it seems clear that we have already had the big recovery story and commentators are only looking for relatively modest gains from this point.
Meanwhile, the various renting options available to prospective vendors mean that they have more discretion than in the past, as to when or whether to sell at all. With the prospect of inflation-beating house price increases across many local markets, and house price values well anchored generally, the incentives to offer property for sale may be weaker than in earlier periods.
The impact of regulation
We envisage that recent regulatory actions will contribute towards a gentle trajectory for the mortgage market.
Lenders are not anticipating dramatic changes as a result of MMR, but nevertheless the more prescriptive nature of its affordability rules may narrow the scope for underwriting discretion at the margins.
The macro-prudential regulator, the Bank’s financial policy committee (FPC), announced two mortgage-related actions in late June:
- when assessing affordability, mortgage lenders should assess whether borrowers could still afford their mortgages if base rates were to rise by about 3%;
- no more than 15% of a lender’s new mortgages should be more than 4.5 times a borrower household's income
While policy-makers trailed the likelihood of interventions several months in advance, and the policy intention has been to insure against future market excess rather than curtail the immediate lending environment, the FPC’s actions may nevertheless shrink overall risk appetite. For example, as we set out in our latest market commentary, lenders who have relied less on the interest rate stress test within their affordability decisions may be slow or reluctant to re-engineer their models, and lenders may seek to maintain a buffer below the 15% loan-to-income cap.
Macro-prudential actions certainly have some potential to reinforce the more conservative risk appetite engendered by MMR rules.
Activity was stronger than we had anticipated in the closing months of 2013 and first few months of 2014, and these baseline effects provide much of the explanation as to why we have modestly revised up our forecast for industry gross lending this year.
Chart Three: Gross and net mortgage lending, £ billion
We now expect gross lending this year to rise above £200 billion, for the first time since 2008.
The growth in lending continues into 2015, but this is likely to be at a more sedate pace, as momentum in the housing market diminishes under growing affordability pressures.
The latter is likely to impact more noticeably on first-time buyers, such that their share of overall loans for house purchase retreats from recent 14-year highs.
The FPC will formally review the Help to Buy scheme in September. For the purposes of these market forecasts, we have assumed that there are no fresh announcements which materially affect take-up. The Treasury has, of course, already announced that no sales under Help to Buy should be on more than 4.5 times income multiple, following the recent macro-prudential interventions.
On this basis, Help to Buy schemes seem likely to account for a growing share of overall first-time buyer transactions over the short-term.
For many movers, and indeed those looking to remortgage, an improving labour market, alongside strengthening house prices for many, may well outweigh modestly higher mortgage rates, and so result in more positive trends for these borrowers over the forecast period.
We envisage a further gentle recovery of remortgaging from earlier 15-year lows. The prospect of higher rates will in due course provide a much stronger incentive to remortgage, but the impact may be limited during the early stages of rate tightening of our forecast period.
Arrears and possessions
Trends in arrears and possessions trends have been moderately benign over recent months.
Chart Four: Arrears by % of balance outstanding in arrears
Although the prospect of interest rate rises feels more imminent than six months ago, an indirect consequence of macro-prudential actions may be that they help to mitigate the overall extent of interest rate rises this year and next.
There is a degree of uncertainty as to the possible impact of rate increases, given that households have not experienced such an event for seven years and that the backdrop is one where there has been a protracted fall in real incomes and uncertainty about future income growth.
Given a favourable jobs market, however, it seems reasonable to think that the majority of households will cope well with initial gentle rate rises. Where households are financially stretched and do not have coping strategies, arrears will build, although this should be relatively slowly over time. As such, while we envisage an increase in arrears over our forecast period, any pick-up in possessions should be fairly muted.