The UK economic outlook is unchanged as a consequence of the Chancellor’s Budget. We concur with the Chancellor’s view that the growth rate will be in the region of 2.25 per cent this year, slightly below the UK long-term growth annual rate of between 2.50-2.75 per cent. His 3 per cent per annum growth projections for 2007 and 2008 appear to be somewhat optimistic. Our view is in line with the consensus forecast of 2.50 per cent per annum next year and in 2008.
Business investment spending has fallen in recent months, and the Confederation of British Industry (CBI) expects only a modest recovery in investment this year and next. The Chancellor, given his adherence to the established fiscal rules, has no room to stimulate economic growth by means of substantially increased government expenditure. The key driver of growth is likely to remain the consumer. The housing market could play a significant role in UK recovery.
Base Rate
Our Base Rate forecast has changed during the past month. This reflects the upward trend in international interest rates, which has reduced the Bank of England’s (BoE) room for manoeuvre.
We now expect Base Rate to remain on hold throughout 2006. UK growth is still expected to be at, or below trend, but the prospect of a more rapid increase in US and euro interest rates is beginning to impact on sterling. Interest rate differentials play a major role in foreign exchange sentiment. Our current view is that the BoE’s Monetary Policy Commitee (MPC) will be reluctant to reduce Base Rate at a time when euro and dollar money market rates are on a rising trend. The prospect of more substantial US monetary tightening has also increased the level of UK longer-term rates. Nevertheless, we see very limited further upside in UK period rates, given that the UK Base Rate is likely to remain on hold for some time.
Resilient housing market
The housing market has maintained its momentum. The most recent Royal Institute of Chartered Surveyors (RICS) survey was relatively upbeat on housing market prospects. New buyer enquiries rose for the ninth month running and there was a significant increase in the expected prices component. Lending data from the Council of Mortgage Lenders (CML) showed a record February gross lending figure. We estimate that on a seasonally adjusted basis, gross lending in first quarter 2006 has been running at a level in excess of £300 billion per annum, whilst net lending has been running at an annual level in excess of £100 billion. The recent increase in the number of first-time buyers (albeit with a significant parental contribution) has provided a boost to the housing market. The strong level of mortgage activity contrasts with the more subdued levels of first-half 2005, a time when UK economic growth was well below trend. The UK economy has since recovered to a growth rate which is close to the long term economic growth rate of 2.50 per cent per annum.
Inflation
The housing shortage has been the primary factor behind the continuing upward movement in house prices. This year, we anticipate that some 225,000 new houses will be completed. This figure is well above the recent average of 180,000 per annum, but far below the estimated 300,000 houses per annum which are required to bring average house price inflation down to the general level of retail price inflation. The Chancellor did make reference to an extra 100,000 houses in his Budget. There was no reference in his speech to the time frame for the additional building. It will take years of increased house building activity to bring national housing supply and demand into balance. Even then, there are likely to be imbalances in certain regions and sectors of the market. Demand for housing is largely driven by personal disposable income and interest rates. Whilst the net personal taxation rate is gradually rising, we still believe that the rise in average earnings will outweigh this factor, and that the employment rate (the percentage of the working age population in employment) will remain around the current level of between 74 per cent and 75 per cent. We expect both Base Rate and longer term rates to be relatively stable in 2006.
Laurence Sanders is economist at Bristol & West Mortgages
