It is clear the housing market achieved a soft landing in 2005. House prices rose by 3 per cent in the twelve months to end 2005, based on Nationwide house price data, and by 5.1 per cent based on the Halifax price index. Most other leading house price indices were in positive territory during the fourth quarter 2005. The housing market has withstood a significant degree of monetary tightening and a stronger than expected slowdown in the UK economy.
There is a close correlation between trends in the UK housing market and UK economic growth. The British economy did slow in 2005 but it did not stall. The rate of economic growth remained positive in every quarter.
The latest data shows that UK growth, as measured by gross domestic product, rose by 1.7 per cent in the year to third quarter 2005. Throughout most of the year the employment market remained resilient with the underlying measure of unemployment remaining under 5 per cent, while the total number of people in employment rose.
Higher interest rates did significantly reduce the level of house price inflation, from around 15 per cent in fourth quarter 2004 to the current level of 3 to 5 per cent (based on the Nationwide and Halifax data). This year Bristol & West forecast the annual rate of economic growth will rise steadily to an annual average of 2.2 per cent. With no upward pressure on interest rates, a gradual recovery in the economy should provide a positive backdrop for the housing market. We predict the average house price will increase by 5 per cent in 2006. Supply constraints will continue to exert an upward pressure on prices in many sectors of the residential housing market.
Interest rate outlook
The interest rate outlook in 2006 is moderately positive from a mortgage lending viewpoint. The current forward market view is that the next change in UK base rate is more likely to be a downward move. The minutes of the December Bank of England Monetary Policy Committee (MPC) meeting show that the vote was 8-1 in favour of no change, and the one dissenting vote was for a reduction in base rate. Subsequently, a second member of the MPC stated the recent decrease in the underlying rate of inflation to 2.1 per cent provided room for a reduction in base rate. We do not expect to see any change in base rate during the winter months, but at some stage in mid-2006, we believe a 0.25 per cent reduction in base rate is likely if, as the consensus analyst forecast predicts, UK growth remains below the trend level of 2.5 per cent.
Longer term rates are driven by a combination of international and domestic factors. We believe there is limited downside in two to 10 year period rates, given the prospect of further increases in eurozone and American benchmark interest rates. The USA is, however, at a very mature phase of the monetary tightening cycle. The scope for higher euro interest rates is limited by the high rate of unemployment in continental Europe. From time to time there may be upward spikes in UK swap rates when US or eurozone benchmark rate increases are anticipated. However, UK economic fundamentals suggest the underlying trend in UK period rates is likely to vary between neutral and a minor downward move.
Mortgage lending
The outlook for mortgage lending in 2006 is relatively positive. Data to end November suggests the total level of net lending in 2005 was in the region of £90 billion. This year we expect net lending to be in the region of £100 billion. While we are confident the housing markets’ soft landing is sustainable, the risks to any housing market forecast must be recognised. These primarily fall into three categories – energy prices, geopolitical and the high level of unemployment in continental Europe.
These risks must be put into perspective. The substantial rise in oil prices has not made a significant impact on the rate of global economic growth. Geopolitical factors have always existed, although their nature has changed significantly over time, and they have rarely made a significant impact on the UK housing market. The weakness of continental European economies is more of a threat to the UK economy, although recent survey evidence suggests there has been an upturn in the economies of continental Europe, hence the recent increase in the euro benchmark interest rate to 2.25 per cent. On balance, our perception is that the outlook for the mortgage market in 2006 is positive.
Laurence Sanders is economist at Bristol & West
