* £24,000 increase in house prices in last year
* Upside risk to 15% house price forecast
£145,918
Commenting on the figures Alex Bannister, Nationwide's Group Economist, said: "The rapid rise in house prices was sustained into May with the price of the average house increasing by 1.9% during the month. As a result, prices are now £24,000, or 19.5%, higher than in May last year. In the first five months of this year prices have risen by more than 9%, compared to a rise of 5.8% over the same period last year.
"Our house price forecast for the 12 months to December 2004, which remains at 15%, implies an average monthly rise of just 0.7% for the remainder of the year. We expect the combination of muted post tax earnings growth, further interest rate rises (we expect rates to rise to 4.75% by year end) and a downgrading of homeowners’ price growth expectations to slow the market over the second half of the year. However, given the current momentum in the market there is now some upside risk to our forecast. With many potential first-time buyers currently unable to enter the market and also high and persisting real debt burdens constraining existing homeowners’ ability to trade up in the future, there is a growing potential for a drawn out period of low activity and low price growth.
A more "hawkish" tone from the MPC drives interest rate expectations higher
"Following the May MPC meeting, interest rates rose by 25bp. This, the third increase in just seven months, was widely expected. However, the inflation report and minutes of the May meeting take an increasingly hawkish tone on the pace of consumer spending, consumer borrowing and the housing market in general. As a result, market interest rate expectations have moved sharply higher in the expectation that monetary tightening, possibly including a 50bp rise, will be more aggressive than previously assumed. The market is now pricing in short rates of 5.30% by the end of the year — only two months ago year-end rates of 4.74% were being priced in. Whilst we agree with the need for the MPC to gradually raise rates, we expect base rates of 4.75% by year end will be sufficient to meet the inflation target.
Rise in prices mirrored by activity
"Consistent with the strength seen in the consumer sector, housing market activity has picked up. March saw the value of mortgage approvals for house purchase reach a record level of £17.6bn, 72% up on a year earlier. The number of mortgage approvals for house purchase - at 151,000 - equalled the highest level for at least 10 years. In contrast, the growth in remortgaging appears to have reached a plateau with approvals for remortgage up 9% year-on-year in value terms and just 2% year-on-year in terms of the number of cases.
"Demand for property - especially among existing homeowners with mortgages - remains high. First-time buyer numbers have declined but to some extent they have been offset by the rise in buy-to-let. In contrast, the supply of property onto the market remains constrained. Despite prices doubling over the last four and a half years, the rate of new build has remained broadly constant at 160,000 homes per year and many previously occupied dwellings now sit empty. Additionally, whereas first-time buyers represent net new demand for property, homeowners passing away represent net new supply. The number of people passing away in the UK has declined (from around 560,000 per annum in the 1990s to around 530,000 per annum since 2000), further constraining supply. An existing homeowner moving house represents both demand and supply for property. The imbalance between supply and demand will be exacerbated if existing homeowners delay placing their property on the market while searching for their ideal home.
Still a game of two halves
"So far this year house prices have risen by an average of 1.8% per month. Our house price forecast for the 12 months to December 2004, which remains at 15%, implies an average monthly rise of just 0.7% for the remainder of the year. We expect the market to slow over the second half of the year partly as a result of relatively muted post tax earnings growth (up 1% year-on-year in March) and rising interest rates. On the basis of the current market expectation that rates will rise to 5.30% by year end, initial mortgage interest payments would rise to 30% of take home pay, from the current 26%. However, sentiment and future price expectations are also key to the market at present. UK annual house price inflation has been in double digits for 49 of the last 57 months and, as a result, the expectation of double digit price rises persisting has probably become ingrained for many homeowners. The current pace of price growth is ultimately unsustainable but a slowdown in growth will require a downgrading of price expectations, especially outside of London and the South East.
It could take four years for first-time buyer affordability to return to 2002 levels
"Although many potential first-time buyers are currently unable to raise the funds required to purchase a property (first-time buyers represent only 30% of all house purchase transactions compared to around 50% five years ago), many existing homeowners who bought prior to the recent rise in prices have relatively low levels of debt and will be in a position to trade up. For example, someone on average earnings who bought their first home at the start of 1996 with a mortgage for 90% of the value would have had a mortgage of just under £36,000. By the start of 2004 their property would have been worth £113,000 (£83,500 of this would be equity) and by taking a loan of typical size in relation to earnings they could now afford to trade up to a property worth £155,000. Although homeowners trading up is supportive to the market at present, the pool of existing homeowners able to extend their mortgages in this way is depleting and this will tend to act as a drag on the market in coming years. Over the longer term first-time buyers will be important in sustaining the market. Just 367,000 first-time buyers entered the market in 2003, down from 525,000 in 2002. This suggests that affordability in 2002 was at a level that allowed significant new entry. Taking this level of affordability as a crude benchmark, if prices remained unchanged it would take around four years for first-time buyer affordability to return to the 2002 level.
"The likelihood of a potentially drawn out period of low house price inflation is rising. Some have argued that if house price inflation fell to low single digits or even zero there would be a significant risk of price falls. However, there are several examples of low house price growth not leading to subsequent price falls: including London in early 2001 and since mid 2003, in the UK for much of the 1950’s and 1960’s, and recently in both the Netherlands and Ireland. In the absence of a recession and large increases in unemployment, significant downward pressure on prices would be unlikely. Even if unemployment did rise the likelihood is that interest rates would be cut aggressively. Unlike in equity markets, many homeowners would simply sit tight, resulting in a period of low activity and low price inflation".
