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Analysis

Published: 20 August 2015 | Author: Mo Jamei

  • Housing and mortgage market activity should continue to be supported by a strong economic backdrop as we head into the second half of the year, with low unemployment, near zero inflation and strong pay growth.
  • A shortage of properties on the market coupled with house price levels which are already elevated and continuing to outpace earnings across much of the country, will weigh on activity.
  • After a rate rise was briefly touted as a possibility in 2015, expectations of the first rate rise have receded towards the middle of 2016.

Introduction

Growth bounced back in Q2, with GDP growing 0.7% in the three months to June. The Bank of England now expects the UK to grow 2.8% this year, from a previous forecast of 2.5%.

Economic fundamentals for the UK look set to remain strong, helped by low inflation, rising incomes and low unemployment. This is helping underpin housing market demand.

Labour market data suggest jobs growth could be slowing, as the number of people in work fell 63,000 in the three months to June, compared to the first three months of the year. The unemployment rate remains at 5.6%.

Strong GDP growth and a fall in the number of people in work could mean UK productivity is finally starting to recover.

Earnings growth continues to perform well, with regular pay 2.8% higher compared to last year. This coupled with near zero inflation gives workers the highest boost in real terms since 2007.

The current period of low inflation is expected to continue well into 2016, with inflation forecast to return to the 2% target within two years.

Chart 1: Average weekly earnings and CPI inflation

20150819 - Market commentary Aug 2015 chart 1

Source: Office for National Statistics

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The Bank of England’s August inflation report highlighted the direction of the labour market being the largest source of uncertainty in the Monetary Policy Committee's (MPC) forecasts. Something the MPC were more confident about was attitudes towards deflation, as they continue to see little evidence in wage settlements or spending patterns to indicate a deflationary mindset being adopted by households or businesses.

The prospect of an interest rate rise this year has once again diminished, after it was briefly touted as a possibility in the lead up to August’s MPC decision. The profile of rate rises expected by financial markets has risen slightly with rates expected to reach 1.7% by 2018 Q3, about 0.25 percentage points higher than in May with the first rise coming before mid-2016. The profile of expected rate rises still remains very gentle and limited though, something the MPC reiterated in the minutes of their August meeting. 

Housing market

Over the past few months activity has picked up and approvals data suggests this is likely to continue into the second half of the year. This was in contrast to 2014 where activity started the year strongly, and began to slow after the first quarter.

Demand in the housing market looks set to remain strong, underpinned by a recovery in the economy. Consumer confidence has bounced back recently with people more confident about personal finances and the economy, mortgage rates remaining close to historic lows, wage growth continuing to be robust and approvals for house purchases at their highest level since the start of 2014.

Looking ahead, the MPC expect approvals for house purchase to average around 68,000 per month in Q3. This supports our view of a stronger second half to the year relative to the first half.

Chart 2: Monthly approvals for house purchase, including MPC forecast

20150819 - Market commentary Aug 2015 chart 2

Source: Bank of England

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On the supply side, there remains a shortage of properties coming on the market according to the RICS survey, as the stock of properties per surveyor hit an all-time low in July. The survey cited would-be movers being put off marketing their property as they cannot see properties they want to buy themselves, which is creating “somewhat of a vicious cycle” in the market.

The Bank’s summary of business conditions survey also points out a shortage of properties as well as going on to say that home owners in areas where house price growth has been limited are now finding it hard to transact as they have limited equity in their current property. This is reported to be dampening transactions as well.

Renewed demand coupled with the lack of supply of new properties coming onto the market is pushing up house prices across most of the country. All major house price indices are currently showing prices increasing at a faster annual rate than earnings. It remains to be seen whether the increase in demand will lead to an increase in supply of properties up for sale. In the near term at least, it is likely house price growth will remain strong.

Our forward estimate of gross lending in July is £22.0 billion. This is the highest lending figure since July 2008, though it should be noted that July tends to the strongest month of the year as spring activity in the housing market typically feeds through to mortgage advances in the summer. Adjusting for these seasonal factors, the figure is likely to be comfortably above last month’s figure, but by a smaller margin.

The extent to which activity can persist strongly is difficult to gauge as the fundamentals underpinning the housing market come up against affordability pressures. Overall, there is limited upside potential for activity if as we expect, house price growth continues to be strong and puts more pressure on affordability.