Published: 16 December 2014 | Author: Bernard Clarke
- We expect mortgage lending to grow in 2015 and 2016, but more slowly than this year.
- Gross and net lending of £240 billion and £38 billion respectively in 2016 would nevertheless represent the strongest performances since 2008.
- A gentle upward trajectory for the mortgage market going forwards should calm macro-prudential concerns.
- The proportion of cash-financed transactions has shown signs of stabilising in 2014, and may decline gently as mortgage availability continues to improve.
- Prospects for economic growth, job creation and a pick-up in earnings are relatively positive, and these factors, along with the easing in interest rate expectations over recent months, should underpin housing market sentiment.
- The welcome reform of stamp duty announced by the chancellor in his autumn statement will also benefit activity in the short-term.
- Housing market activity has nudged lower since the summer. This is consistent with our long-standing view that affordability considerations would limit the scope for transactions to return to longer-run norms. We expect the pace of house purchase in 2015 and 2016 to be a little below this year’s level.
- Buy-to-let lending should continue to make some headway, although this may be limited by uncertainties about the appetite to regulate it or the activities of landlords more generally.
- Some further improvement in mortgage arrears and possessions is possible in 2015, before a relatively modest reversal as interest rates increase gently through the second half of our forecasting period.
CML market view, December 2014
|Residential property transactions, UK
|Arrears, 2.5% or more of balance at end period||Possessions in period|
The UK experienced a strong upturn in housing market activity and mortgage lending through 2013 and the first half of 2014.
Economic fundamentals have strongly underpinned this recovery.
The impetus has been fading in recent months, however, on the back of slower house purchase activity, and this inevitably colours prospects for further growth in mortgage lending.
Chart One: Activity in housing and mortgage markets
While regional effects have been at work, we see the slowdown as primarily reflecting the affordability pressures associated with the elevated nature of house prices relative to incomes.
We are much less optimistic than other commentators such as the Office for Budget Responsibility, on whether annual housing market transactions (on the HM Revenue & Customs measure) can climb back to the level of between 1.4 and 1.5 million seen as the longer-term norm. Indeed, in our view, a slightly softer housing market will provide the backdrop for our market forecasts through 2015 and 2016.
This, in turn, suggests that further recovery in mortgage lending activity may be rather limited over the next two years, especially as there are a number of uncertainties and mostly downside risks in several areas that have previously supported the housing market revival.
The revival of the UK economy over the past two years, following a protracted recession, has gone hand in hand with greater business and household confidence and a much stronger jobs situation. This has done much to underpin the recovery in housing market activity and prices.
As one would expect, much of the “bounce” associated with the initial stages of recovery has now faded. The short-term picture for the UK continues to look resilient, however, with economic growth settling down into a range of between 2% and 2.5%, not far from its long-run average.
We see two principal risks, both on the downside, as far as the UK economy is concerned.
The first relates to deteriorating prospects for the global economy, and particularly in the eurozone, where there are concerns about low growth and deflationary pressures. This has the potential to reduce UK growth, by dampening export prospects and financial market confidence. While any short-term impacts can largely be mitigated through monetary measures, this has limits and risks tilting the UK to even greater reliance on stimulating domestic demand.
This brings us to our second concern, which is the extent of our reliance on further strong growth in consumer demand.
Much of the recent growth in consumer spending has depended upon the willingness of households to lower their savings as their confidence in job security and renewed ability to access credit increases. There are limits to how low savings can go, of course, and looking ahead, prospects for sustainable growth in consumer spending appear to depend upon a meaningful and lasting recovery in real pay.
While the rate of pay increases remains subdued, the headline consumer price index (CPI) has fallen since last autumn and is now comfortably below its 2% target. This has narrowed the gap between pay and CPI increases to a whisker. This certainly makes the prospect of a recovery in real pay more plausible, but still not a foregone conclusion. It is worth remembering that few commentators have a good track record in predicting UK labour market developments.
Mortgage credit availability
As well as stronger economic fundamentals, better mortgage credit availability has played a key part in supporting the recovery of housing market activity and mortgage demand over the past two years.
The general trend in mortgage pricing has been downwards, helped by lower mortgage spreads and funding costs.
We have seen a material compression in mortgage spreads through 2013 and 2014, according to Bank of England estimates. Although they remain elevated compared with the period before the credit crisis, the Bank’s conditioning assumptions, published alongside its inflation report, indicate only modest further change through 2015 and 2016.
With recent credit conditions surveys suggesting that lenders’ risk appetite may be reaching its limit - perhaps reinforced by the implementation of the mortgage market review (MMR) in April and subsequent macro-prudential announcements – narrowing spreads may diminish as a source of improving mortgage credit availability over the next two years.
A little more positively, UK interest rate expectations have eased a lot since the summer, as more pessimistic global growth prospects have helped funding conditions and lowered inflationary pressures.
According to the Bank of England’s latest inflation report – which we use to generate our forecast scenario – we may not see the first base rate increase until late 2015, with further increases of 25 basis points taking place roughly once every six months through to late 2017.
Chart Two: Mortgage pricing on new loans
While this has helped UK lenders compete more intensely for business in recent months and will continue to support market activity over the short-term, such conditions may not be sustained, and the risks now weigh on the downside.
The recent announcement from the authorities, that the Funding for Lending scheme will now remain open until January 2016, underlines their wish to ensure the continued availability of cheap funding. However, the scheme is more narrowly drawn than at the start, and so has become progressively less relevant for mortgage firms.
Government housing measures
Government initiatives, and in particular its Help to Buy schemes, have provided a significant boost to housing market sentiment and sales, particularly for first-time buyers and away from London.
Chart Three: Help to Buy transactions
Sales under the mortgage guarantee scheme, formally launched from the start of 2014, now exceed equity loan sales, but the pace of activity has shown signs of levelling off in recent months.
The equity loan scheme, with its clear link to the provision of newly-built property – a policy focus of all the major political parties – seems likely to persist in a recognisable form throughout our forecast period.
By contrast, the mortgage guarantee scheme – already scheduled to close at the end of 2016 – is, despite its recent clean bill of health from the Financial Policy Committee, subject to some degree of political risk, depending upon the outcome of the general election next May.
A number of lenders continue to offer attractively priced higher loan-to-value mortgages outside of the guarantee scheme, and this makes it difficult to gauge how take-up under the scheme might evolve over the next two years.
Should the mortgage guarantee scheme remain in place through to the end of 2016, as scheduled, and continue to attract large numbers of first-time buyers, we could see a rush of applicants – some bringing forward their purchase plans from 2017 - to make use of the scheme during its final months. Such behaviour could impact overall market numbers and composition in the second half of 2016.
Elsewhere, the chancellor’s reform of residential stamp duty, announced in his autumn statement, should buoy house-buying sentiment and activity modestly in the short term.
Chart Four: Effective rates of residential stamp duty
Effective tax rates have been lowered across most property values, reducing for most the immediate up-front cost of house purchase. Looking further ahead, the benefit for households becomes progressively more limited, as house prices reflect some of the change and fiscal drag pushes up stamp duty levies once again.
The London market
One of the defining hallmarks of the housing market recovery has been the very strong growth in house prices in and around London.
Given that mortgaged sales in London account for roughly one in seven UK transactions, developments around the capital clearly affect the national picture. They may also have indirect adverse confidence effects on the wider UK market.
A number of special factors, related to London’s appeal to overseas investors as a global city, underpinned a sharp recovery in prime areas of the capital such as Chelsea, Kensington and the City, but this has given rise to only limited ripple effects further out. Large parts of the country are experiencing a much more muted recovery, anchored more closely to developments in the wider economy, jobs market and interest rates.
Since the summer there have been clear signs of the London market cooling, one consequence of which has been to shave national house price inflation metrics lower.
A number of plausible reasons – including limits to investor appetite, nervousness about mansion taxes, affordability pressures for mortgage borrowers, and anticipation of macro-prudential intervention or interest rate increases – have been put forward as explanations. All of these may have played a part.
It is not clear whether this cooling of the London market represents just a temporary pause for breath or a more lasting inertia. Our instincts incline us to a protracted period of more subdued activity, but with relatively more first-time buyers and more highly leveraged transactions in and around the capital, we do not entirely discount the possibility that expectations of interest rates being low for longer, if sustained, could trigger renewed house-buying activity.
Moreover, the chancellor’s recent reform of the stamp duty regime seems likely to disproportionately benefit the mainstream London market, given that it offers relatively large savings above the £250,000, £500,000 and £1 million thresholds.
And, even at the top end of the London market, adversely affected by the imposition of higher stamp duty levies, there may be an indirect benefit. Some of the recent softness in the market for prime properties may be due to purchasers standing on the side-lines, because of uncertainties associated with the possible imposition of mansion taxes. To the extent that such individuals now judge that these risks have lessened, this may facilitate an earlier recovery at the top end of the market.
Chart Five: House prices in London and the rest of the UK
As we expected, there have not been dramatic changes or lasting market disruptions as a result of the Financial Conduct Authority’s implementation of the new mortgage market rules in April.
The two mortgage-related actions announced by the macro-prudential regulator, the Financial Policy Committee (FPC), in June – that lenders should assess affordability in the event of mortgage rates rising by 3% and limit loans above 4.5 times a borrower's income to no more than 15% of new lending – have now taken effect.
While these requirements have not led to a sea change, they are likely to have heightened awareness around specific risk metrics. So, for example, the data from our regulated mortgage survey shows that lenders advanced relatively fewer high loan-to-income mortgages in the third quarter, across most regions and borrower types. Across the UK as a whole, new loans above 4.5 times income dipped from 9.5% of total new lending in the previous quarter to below 9%.
Even though the Bank has signalled in recent months that housing market activity is weaker than it had anticipated, we should not expect macro-prudential scrutiny to relax.
Mortgage lending forecasts
Reflecting the uncertainties about wider economic developments and housing activity beyond the next few months, we think that transactions will ease back modestly in 2015 and thereafter broadly settle.
Although this sets some broad tram lines for our gross lending figures, the relationship with mortgage lending values is not necessarily one to one.
Chart Six: UK residential transactions by type
Cash-based transactions have grown in importance to account for more than a third of market sales, with the reduced availability of mortgage credit following the credit crunch. The cash proportion of sales peaked at nearly 36% in 2013, according to our estimates. This year, as mortgage credit availability has improved, mortgage-financed transactions have grown at more or less the same pace as cash transactions, and so the latter’s proportion has remained fairly steady.
Looking ahead, we anticipate that cash transactions will progressively edge back down nearer to a third of sales, and so to a limited degree allow for a softer decrease in the volume of mortgage-financed sales than for the overall market.
With typical loan size echoing some further modest increases in house prices, we expect the value of lending for regulated house purchase to move a little higher to about £120 billion in 2015 (2014: £115 billion).
We have pencilled in only modest growth in remortgage activity over our forecast period, as current market expectations for base rates mean that the incentives for households to refinance change only slowly over time.
The underlying conditions for remortgaging become progressively a little more fertile as a result of rising house prices and household incomes over time, but an indirect unintended consequence of the MMR may be that more borrowers opt to refinance with their existing lender than in the past (typically, such activity would not be captured in remortgage estimates).
With strong fundamentals in place for the further expansion of the private rented sector, we expect to see further expansion of buy-to-let activity, relative to gross mortgage lending and the volume of property sales, over time. Buy-to-let activity is subject to a degree of regulatory uncertainty on several fronts, however, and this brings risks for its continuing orderly evolution.
The buy-to-let sector has attracted a degree of attention, both in the context of the FPC’s deliberations about seeking additional powers of direction and HM Treasury proposals for applying the European mortgage credit directive here in the UK. HM Treasury has deferred a decision on whether the FPC should have powers over the buy-to-let sector, pending a separate review in 2015.
The evolution of the private rented sector as the second largest form of tenure has also brought with it closer scrutiny from policy-makers.
Gross and net lending forecasts
Bringing all of our analysis together, we expect industry gross lending to climb modestly from £207 billion this year, to £222 billion in 2015, spread across regulated and BTL lending, house purchase and remortgage.
We envisage stronger growth to £240 billion in 2016, as cash purchases ease back and nominal incomes growth supports resilient house prices and loan values.
Helped by the strong recovery in first-time buyer numbers, net lending has finally broken out of the narrow range of between £10 billion and £15 billion that it has traced since 2008. Net lending is likely to have more than doubled to £25 billion this year. Although first-time buyer numbers may edge lower over the next two years, we expect further modest growth in net lending to £32 billion and £38 billion in 2015 and 2016.
Arrears and possessions forecasts
Trends in mortgage arrears and possessions have continued to be benign. Arrears and possessions are now at their best levels since 2006.
Chart Seven: Arrears by % of balance outstanding
With financial markets moving the prospect of interest rate rises out to late 2015 and beyond, and at least some prospect that the protracted period of declining real incomes may be coming to an end (for the majority, if not all households), there is little reason to anticipate major changes over our forecasting period.
We expect to see only modest further improvement in 2015 from where we are today.
As interest rates begin to rise gently from late 2015 onwards, the long period of advance warning and the benign trajectory helps to work against sharp deterioration.
Looking ahead over the next two years, housing and mortgage market developments appear well supported by relatively favourable economic fundamentals. However, prudent and sustainable lending in the face of ongoing affordability pressures necessarily limit the further upside scope for mortgage lending.