• UK consumer sector remains buoyant
• Base rate will probably rise to 5% within the next six weeks
• Mortgage lending remains resilient, although we expect the rate of growth to slow in 2007
• Average house price forecast to rise by 4% next year.
UK consumer sector remains buoyant
the most recent consumer statistics show that the annual growth of retail sales rose by 4.3 per cent in the 12 months to July. Data was stronger than expected in a number of sectors, including household goods and furniture – which partly reflects the strength of mortgage demand. An upturn in investment has also played a significant role in UK economic expansion.
In the first half of next year we expect to see the economic momentum maintained by net exports as the eurozone economic recovery gathers momentum. The eurozone represents the largest single market for UK traded goods. The Bank of England’s (BoE) monetary tightening policy will take some 12 to 18 months to fully impact on the UK economy. The policy is designed to bring the economy back to trend growth. We therefore expect the UK growth rate in the second half of 2007 and 2008, to be 2.5 per cent year on year. The primary risk to the UK economy is thought by many economic experts to be the prospect of a major slowdown in the USA. We believe this factor will be balanced by more rapid economic expansion in Eastern and Western Europe.
Base Rate
The BoE Monetary Policy Committee (MPC) left Base Rate on hold at the September meeting. However, the unanimous MPC vote provides no ground for interest rate complacency. There is a very high probability that Base Rate will be increased by 0.25 per cent on either 5 October or 9 November.
At present, the decision as to whether Base Rate will be increased next month or in November is a close call. We believe that given the recent appreciation of the currency, the BoE should keep rates on hold in October to provide breathing space for UK exporters. There is a possibility of a move to 5.25 per cent in the New Year.
The BoE’s prime mandate is to maintain inflation (CPI) within a 1 per cent to 3 per cent target range. Last month, CPI rose to 2.5 per cent, and there are further significant price increases in the pipeline, including tuition fees and utility prices. Our view remains that in the interests of the wider economy the BoE should confine its monetary tightening to a maximum of 5 per cent. This level is priced into period rates (two years and beyond), determined by a combination of international and domestic forces. The international forces are more pronounced in five-year plus rates, which have fallen back in recent weeks. We expect two to five-year rates to remain in the region of current levels in the run up to year end, although there could be a degree of volatility.
Mortgage lending resilient
Mortgage lending remains close to the highs of the year. The level of gross approvals has recently been running at an average of £29bn per month. The approval statistics are compatible with a gross lending figure for 2006 as a whole of £340 billion. Our net lending forecast for this year is £105bn.
Next year, we expect growth to slow in response to the rise in mortgage rates.
In 2007, we forecast that net lending will increase by £5bn to £110bn. Gross lending is forecast to rise by £20bn to £360bn.
One feature of mortgage lending this year has been the growth of buy-to-let. We estimate this sector now accounts for over 10 per cent of gross lending. While there are distinct risks to the mortgage lending forecasts following the rise in Base Rate, our view is that the housing market plays a key role in UK economic expansion. If the market were to experience a slowdown next year, we expect the BoE to respond with the necessary reductions in rates.
Average house price inflation
At the start of this year, we were among the most optimistic of house price forecasters. Even we have been slightly surprised at the extent of house price inflation this year. The latest Nationwide and Halifax price shows weighted average house price inflation
to be in the region of 7 per cent to 8 per cent per annum. This level is not sustainable. Consumer debt servicing costs are rising towards the levels of the early 1990s. To date, this has not resulted in a significant increase in mortgage arrears. The well-publicised personal sector debt arrears are mostly related to shorter-term loans and credit cards. The high level of personal sector gearing does however limit the scope for future price increases.
We forecast that average house prices next year will increase in line with the expected rise in average earnings i.e. in the region of 4 per cent. In 2008, we expect to see a marginal increase in the rate of house price inflation to 5 per cent, reflecting our forecast of a reversal of this year’s monetary tightening. The scope for any setback in the house prices is limited by two factors. The prime factor is the past shortfall in housing supply that will take many years to resolve. The second factor is the high sums being invested in property cash transactions. This factor is most pronounced in London and the South East.
