The UK economy has returned to trend growth, as evidenced by the most recent economic statistics. Gross domestic product (GDP) increased by 0.6 per cent in first quarter 2006, which equates to an annual rate of 2.5 per cent, in line with UK long-term trend growth. The breakdown of UK gross domestic product is now more balanced, following the upturn in manufacturing production in March.
UK industrial production is in positive territory for the first time since the Summer of last year. This apparent more optimistic outlook in the industrial sector has been re-inforced by the latest Confederation of British Industry (CBI) Industrial Trends Survey, which referred to continued signs of improvement in the manufacturing sector during May.
Our one proviso in respect of UK economic prospects is the gradual rise in the unemployment rate to 5.2 per cent. If this upward trend were to accelerate, this would have a distinct adverse effect on consumer confidence. Our central forecast, however, remains one of UK growth remaining around trend, accompanied by a gradual increase in unemployment.
Resilient housing market
The mortgage market continues to make a significant contribution to the upturn in the UK economy. Higher household goods expenditure was a significant factor behind the rise in UK retail sales in April from 2.6 per cent (per annum) to 3.0 per cent.
The latest mortgage lending and approval data fully supports our view that net lending will be in the region of £100 billion. Total net lending in the first quarter of 2006 (seasonally adjusted) was £26 billion. The comparable first quarter gross lending figure of £83 billion is also compatible with our 2006 forecast of £300 billion. Gross approvals in the first quarter 2006 were also in the region of £80 billion plus. Council of Mortgage Lenders (CML) data for April points to a continuation of the strong trend in lending. We expect the housing market to be resilient during the Summer months, although on a seasonally adjusted basis, the underlying trend in lending might be fractionally lower, given the gradual increase in unemployment and the 0.50 per cent plus differential between fixed term lending rates and Base Rate.
Longer-term period rates close to peak
Longer term rates have peaked, at least temporarily. The recent rise in period rates was driven by the trend in internal fixed interest rate markets – both the US Federal Reserve Board and the European Central Bank are in monetary tightening mode. The recent peak in sterling term rates was reached just after publication of the Bank of England Quarterly Inflation Report.
The Bank’s economists forecast that both UK growth and inflation are likely to rise above target in the coming months, before returning to trend on a two-year forecast horizon.
A detailed assessment of the report indicated that the upbeat growth forecasts were based on somewhat optimistic assessments of both investment and net exports. Forward markets now predict that base rate will rise no higher than 5 per cent, and hence two year plus rates have settled around this level. We are more optimistic on the immediate inflation outlook than the consensus view, and believe that one touch of the monetary brakes will be sufficient to bring UK underlying inflation and growth back to trend.
At present, money markets discount one 0.25 per cent Base Rate increase in September, followed by one further 0.25 per cent increase in the first quarter of next year. We continue to forecast that there will be one 0.25 per cent increase in base rate in the first quarter of next year, and that longer-term period rates will be close to current levels at year end.
Predictions
At the start of the year, Bristol & West was one of the most bullish forecasters in terms of house price movements. We were therefore not unduly surprised when the Halifax Price Index rose to an annual rate of 8 per cent per annum. This high number partly reflects statistical factors – the corresponding data last year represented the trough of the housing market downturn.
Other house price statistics, including the Nationwide and Land Registry, point to an annual increase in the region of 5 per cent per annum. There is a clearly degree of momentum in the housing market. The psychological factor is difficult to quantify, but is nonetheless an important element in any house price forecasting analysis.
Other factors have also led us to revise up our forecast of the average UK price by 1 per cent to 6 per cent per annum. There are likely to be significant regional variations. The impact of rising unemployment is being felt in the Midlands and Northern England. The service sectors of the economy are more heavily concentrated in the southern half of the UK, and it is the strength of this sector which is the key driving force of the UK housing market overall.
