HBOS' economic forecast runs as follows:
Key points:
- House prices in the UK are forecast to fall by 2% in 2005. This slight fall follows nine years of rising house prices when the average home has increased in value by almost £100,000, a 160% increase. Beyond 2005, we expect the market to record modest price increases; affordability will also improve, especially for first-time buyers, who will return to the market in larger numbers than in recent years.
- Housing market fundamentals are sound. Past major housing market downturns have all been caused by a combination of economic recession, steeply rising unemployment and significant rises in interest rates directed at controlling retail price inflation. There is very little likelihood of a similar combination occurring over either the short or medium term; UK plc is in good shape.
- There will be some variation in regional house price performance, albeit within a much narrower range than in the last few years. We expect Scotland (3%) and Northern Ireland (4%) to record the biggest price gains whilst the South East (-5%), London (-4%) and the South West (-4%) will experience the most significant price falls.
- In real terms, housing equity is at a record high. We estimate that the value of housing assets exceeds the total value of outstanding mortgage balances by £2,400 billion. Taking general price inflation into account, housing equity is at a record high, at £1,300 billion in 1987 prices, and is 66% higher than in 1989.
- The base rate will fall to 4.25% by the end of 2005. We believe that rates have now peaked at 4.75%, and expect the Bank of England to reduce rates by half a percentage point during 2005. As a result, affordability will improve with the average mortgage servicing cost falling to 16% of earnings for new borrowers.
UK Housing
- Housing market fundamentals are sound. The economy's strength, the high level of employment and low unemployment, together with the lowest interest rates since the 1950s, have been key factors behind the recent sharp rise in house prices. Halifax research shows that employment is the strongest driver of house price movements and the level of employment is currently at a record high of 28.4 million – 232,000 higher than a year ago. Past major housing market downturns have all been caused by a combination of economic recession, steeply rising unemployment and significant rises in interest rates directed at controlling retail price inflation. There is very little likelihood of a similar combination occurring over either the short or medium term.
- We expect earnings growth to outstrip house price growth in 2005 for only the second time in 10 years. Average earnings are predicted to rise by 4.2% in 2005: significantly ahead of house price inflation across most of the country.
- As earnings growth outpaces house price inflation, the ratio of house prices to earnings will fall from a peak of 5.6 in mid 2004 to 5.2 at the end of 2005. This reduction will begin to make it easier for first-time buyers to get onto the housing ladder. Affordability has been a key factor for first time buyers resulting in a sharp drop in their numbers over the past two years. For example, first-time buyers account for for less than three in ten of all new mortgages in 2004 (source: CML). This is well below the longer-term average of almost one in two.
- Affordability remains good and will improve in 2005. The expected modest reductions in both house prices and interest rates in 2005 are calculated to reduce mortgage payments as a percentage of earnings for new borrowers from its current 19% - in line with the long-term average and well below the peak of 34% in 1990 - to 16%.
- Supply constraints, especially in the south of England, will underpin the market. Recent ONS household and population projections for the next 20-25 years show that the demand for additional homes will be even greater than previously believed. The population in London and the South East is expected to rise by around 15% between 2003 and 2028 with an additional 1 million people living in the capital.
- Housing transactions are forecast to be lower in 2005. We expect property transactions in England and Wales to fall from 1.77 million in 2004 to 1.5 million in 2005, according to the official Inland Revenue statistics. Changes to the collection of these figures in 2003 means that these figures are not directly comparable with historical levels of turnover.
- In the medium-term, the market will be underpinned by better affordability and generally good economic conditions. Earnings are expected to increase more rapidly than house prices, leading the ratio of house prices to earnings to decline from its current historically high level. The housing market will be characterised by modest price increases and a steady improvement in transactions beyond 2005.
- There will be some variation in regional house price performance, albeit within a much narrower range than in the last few years. Price rises outside the south of England have contributed over three-quarters of the rise in overall UK prices in 2004. Those regions that have seen the biggest price increases over the past year – northern England, Wales and Scotland – are expected to experience a significant easing in house price inflation next year. Prices, however, are predicted to rise by a small amount with the biggest gains in Scotland (3%) and Northern Ireland (4%). These regions have the lowest prices in relation to earnings, suggesting that affordability issues – particularly amongst first-time buyers – will be a lesser constraint on demand and therefore prices than elsewhere in the UK.
- The South East (-5%), London (-4%) and the South West (-4%) and are expected to record the most significant price falls. We also predict modest falls in East Anglia, East Midlands and West Midlands. These falls will return prices to the levels they were at either late in 2003 or in early 2004. Prices are expected to fall in those regions where house prices are highest in relation to earnings.
- The north/south divide will narrow further. These increases would result in average house prices in the south being 1.6 times as high as in the north at the end of 2005 – well below the peak of 2.2 in 2002 Quarter 2. Taking a longer historical persepective, the north/south divide would be slightly wider than ten years' ago (1.4 in 1995 Quarter 4). In monetary terms, the gap would have widened by more than three and a half times with prices in the south almost £73,000 higher than in the north, on average, at the end of 2005 compared with a premium of £20,000 in 1995 Quarter 4.
Martin Ellis, Chief Economist, commented: "We expect the UK housing market to continue to slow with a slight fall in house prices likely in 2005. Sound economic fundamentals mean that the market will remain in good health; UK plc is in good shape. The will be better news for first-time buyers who will start to find it easier to get a foot onto the housing ladder.
The softening in the housing market is expected to trigger a reduction in interest rates next year as the Bank of England acts to ensure that consumer demand and the housing market remain well underpinned.
Over the medium term, we expect the housing market to enjoy a period of stability. House prices are forecast to rise at a modest rate following next year's slight decline. The shape of the market will change with better affordability meaning that more first-time buyers will be able to purchase a home. The return of first-time buyers, along with generally good economic conditions in the UK, will generate a steady improvement in housing market activity beyond 2005."
