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Published: 25 August 2016 | Author: Bob Pannell

  • A less favourable backdrop for house purchase activity appears to be emerging post-referendum. We estimate that gross mortgage lending was £21.4 billion in July, marginally softer than June, but the first year-on-year drop for more than a year. 
  • The Bank of England has announced a significant monetary stimulus, aimed at supporting the domestic economy during a protracted period of uncertainty and structural change.
  • An innovative Term Funding Scheme means that the 25 basis point reduction in Bank Rate will benefit nearly half of existing mortgage borrowers, but it is not clear how well the Bank’s actions will stimulate borrower demand in a more adverse economic climate.

UK economy

The post-referendum economic landscape is not much clearer than a month ago. Some indicators are more backwards-looking or inherently volatile than others, and this makes it harder to gauge where things currently stand. 

Survey data for July from the much-respected Chartered Institute of Procurement and Supply indicate very steep falls in activity measures, in some cases retreating to levels not seen since 2009, and signal contraction. 

On the other hand, the jobs data for the second quarter was positive, with a record proportion of working age people in work and the headline unemployment rate down to 4.9%, its lowest for more than a decade, and retail sales rebounded strongly in July.

From what we can see, the UK economy appears to have averted a hard landing, at least for the time being.

Post-referendum, forecasters have for the most part been shading down their economic growth forecasts for the whole of 2016, rather than pencilling in more dramatic revisions, according to recent issues of HM Treasury’s forecasts for the UK economy.

This appears to be broadly consistent with the latest view of the Monetary Policy Committee (MPC), in August’s Inflation Report, that the UK is likely to experience sluggish growth rather than outright recession over the second half.

Looking further ahead, however, the MPC sees potentially significant recessionary headwinds as private domestic demand acts as a substantial drag on overall UK economic growth. These headwinds have prompted the Bank to announce a significant monetary response (summarised in the next section).

Chart 1: MPC projections for GDP and inflation

MPC projections for GDP and inflation chart for August market commentary

Source: Bank of England Inflation Report August 2016
Note: Figures reflect median projections, based on Bank policy actions as announced and market interest rate expectations

Download data

Next year looks to be particularly challenging for our economy, with GDP growth shrinking below 1%, with modest growth resuming after that. This is a much weaker picture than was the case in May, but one that is broadly in line with the views of private forecasters.

Inflationary effects, associated with the large depreciation of sterling over recent months, result in CPI climbing above its target 2% for most of the Bank’s forecast period.

Monetary policy

The MPC unveiled a significant package of monetary measures in early August. Reflecting the transmission delays before monetary policy takes effect, the Bank’s timing is designed to provide meaningful stimulus to our domestic economy as growth sags going into next year. 

As well as the widely anticipated 25 basis point reduction in Bank Rate to 0.25%, the Bank of England also announced a fresh round of quantitative easing – with £60 billion of gilt purchases and up to £10 billion of UK corporate bond purchases – and a new £100 billion Term Funding Scheme (TFS).

The latter – in effect a beefed-up version of the former Funding for Lending Scheme – aims to do two things. 

Firstly, to help the cut in Bank Rate influence the borrowing rates actually faced by households and firms. UK banks and building societies can borrow up to £100 billion over the next year at beneficial rates for four years. This should help to offset the financial pressures they would otherwise face, not to lower mortgage and other lending rates as interest rates approach zero.

Secondly, the TFS also aims to support new lending, with firms that grow their balance sheet eligible to draw down a matching amount of additional funds and a system of retrospective scheme fees if balance sheets contract.

In addition to the above measures, the Bank has gone out of its way to suggest that a further cut in Bank Rate later this year is on the cards. 

Importantly, however, the governor Mark Carney has made it crystal clear that the MPC does not want to move to negative policy rates. The Bank clearly has scope to augment other elements of its package, or to deploy alternative policy levers, should economic circumstances warrant it. But there is awareness, within the Bank and externally, that monetary policy cannot be relied on to fully mitigate the adverse economic impacts associated with Brexit uncertainty.

Given this context, market commentators are already beginning to anticipate some complementary fiscal measures when the new chancellor Philip Hammond delivers his first Autumn Statement later this year.

Housing and mortgage markets

As other commentators have noted, survey indicators are softening, and point to weakening demand and slowing house price inflation, especially in parts of the capital.

The latest HMRC data reports that residential transactions in July were little changed from the month earlier. The seasonally adjusted tally of 94,550 marks the fourth month in a row when this metric has been below 100,000.

Whereas activity levels in the Spring would have been adversely affected by the distortions associated with the spike in activity ahead of April’s change in stamp duty, a substantial part of these effects should have worked through by now. 

On balance, it seems likely that the July data may represent the first true reading of a softer tone in the market that has emerged post-referendum. 

Chart 2: Property transactions and gross mortgage lending, 12 month rolling totals

Property transactions and gross mortgage lending, 12 month rolling totals for August market commentary

Source: HMRC, CML

Download data

Were the market to settle down close to this more subdued pace, this would represent a market correction, but would nonetheless deliver an outturn for the year as a whole which would in fact be similar to 2015’s 1.23 million (see Chart 2).

The Bank leans to a more bearish view in August’s Inflation Report, reflecting the sharp deterioration in sentiment captured in RICS’ July survey. It suggests that monthly house purchase approvals may average just 56,000 over the coming quarters. This would be equivalent to an annual rate of overall transactions of less than 1.1 million, which we see as unduly pessimistic at this juncture.

Our forward estimate is that gross mortgage lending in July totalled £21.4 billion. This is only marginally softer than June, but would represent the first year-on-year drop in more than a year. Notwithstanding a pick-up in buy-to-let house purchase lending from very subdued levels, our data contains a hint of some softness in overall house purchase lending showing through.

The strong acceleration in the pace of remortgage activity that we have seen over the past twelve months does of course help to offset any softening of house purchase activity in terms of our overall lending numbers.

As with property transactions, there continues to be some uncertainty as to whether the market distortions associated with April’s stamp duty changes have fully washed through. But July’s figures are consistent with a still robust, but more subdued underlying lending picture (see Chart 2).

The monetary policy actions announced by the Bank earlier in August appear to have ensured that lower Bank Rate is transmitted through to domestic borrowers in the case of mortgages. Tracker products are impacted directly, and most mortgage lenders have announced commensurate reductions to their standard variable rates (SVRs) from September. 

All in all, nearly half of existing mortgage borrowers are likely to benefit from lower mortgage rates. Even though the financial benefits are relatively modest – for example, a typical SVR customer will see monthly interest costs drop by no more than about £20 – the move should help to bolster market sentiment.

What is less clear, at this juncture, is how successful the Bank’s actions will be in supporting lending levels. 

While the TFS should help to ensure that the supply of finance is not a constraint on lending activity, mortgage lenders remain subject to MMR affordability tests and  macro-prudential constraints, and these, together with their own risk tolerances, may leave little opportunity to buoy borrower demand in a more adverse economic climate.

Read our market commentary for July 2016