Key factors
- A robust economy, stable labour market and limited supply continue to support house prices
- Higher interest rates and stretched affordability will act as a drag
- Revival of London market set to continue and to boost neighbouring regions
- Northern Ireland and Scotland to remain strong in 2006 before slowing into 2007, while Wales will be in line with UK average
Commenting on the figures Fionnuala Earley, Nationwide’s Group Economist, said:
“Nationwide has raised its house price forecast for 2006. We now expect prices to increase by around 5%, compared with our December forecast of 0%-3%. The resilience of the market so far this year in the face of deteriorating affordability suggests that there is still enough demand in the market to support prices. However, we expect some softening towards the very end of the year, mainly due to affordability, but also reinforced by the surprise increase in interest rates, which can do nothing other than add to caution.
“At the regional level, the revival of the London market and the remarkably fast growth of house prices in Northern Ireland and Scotland have been the highlights over the past six months. We expect house price growth to remain robust in these regions. However in Northern Ireland the current annual rate of growth of almost 25% is unsustainable and will cool as we enter 2007. The revival of the London market will also feed into the neighbouring regions through the ripple effect.
Housing market strengthened against the odds
“In the face of deteriorating affordability, the housing market has been remarkably resilient in 2006. House purchase transactions reached boom levels during the winter and have remained above trend since. This pulled house price inflation up to 5.9% in July, almost double the 3% rate of growth at the end of 2005. The faster than expected recovery of the economy and strong labour market are important factors. On top of this is the apparent shift in demand for housing as an investment as tenant demand has increased both in the face of rising prices and increased immigration. Strong bonuses in the City will have helped, but so too will any change in attitudes to property investment as a supplement, or alternative, to traditional pensions.
August’s rate rise unlikely to have large impact on housing market
“The MPC’s decision to increase interest rates sent shock waves through the City but is unlikely to have the same effect on the housing market. Our initial view, in advance of the Inflation Report and MPC Minutes, is that this is a pre-emptive move which is likely to have only a modest impact. Money markets had anticipated a rise, so fixed mortgage rates had already risen to around 5.2% from around 4.8% in early April. Tracker mortgage rates will now rise, but less than half of borrowers currently choose these. Also, the impact of a single rate rise is relatively small. On a typical first-time buyer loan, the monthly mortgage payment would increase by around £17. However the rate rise will affect demand at the margins and will cause some to abandon plans to buy, at least for the time being. Landlords’ yields will also be affected as debt payments increase, although the extent to which this chokes off their demand for property depends on the relative returns available on alternative investments and expected tenant demand.
Supply is a supporting factor in the UK market
“The lack of housing supply in the UK is a key supporting factor for house prices. Even with the higher rates of house building seen more recently, taking demolition into account and based on the government’s average projection of 209,000 new households per year, there will be about 47,000 too few homes built each year in England. Such pent up demand for housing can only be supportive of prices, both now and in future years.
Overvaluation modest
“That said, affordability cannot be ignored and as house prices increase faster than earnings, demand must slow. Prices have more than doubled this century and many commentators have suggested that this leaves the market at risk. We have reviewed a number of house price models and estimate that the degree of overvaluation of house prices is no greater than around 15%. Add in likely improvements in the quality of marketed properties and the level of overvaluation seems relatively small, especially when put in context of strong rises in general retail prices and real disposable incomes, along with the fall in borrowing costs over the same period. Any degree of overvaluation will diminish slowly over time, unless there is a market crash. However, the strength of the economy and labour market make the latter unlikely and so we expect there to be only a modest drag on prices.
Looking to 2007
“Overall we expect the housing market to be a little slower in 2007 compared with this year as worsening affordability brings activity levels back towards their long term average. In addition, with higher interest rates and house prices affecting yields for investors, this demand should also begin to cool. However the strong economy, higher income growth and continued lack of supply will still provide a supportive background. On the basis of, at most, one further interest rate rise, we see house prices increasing at around, or just above, the rate of earnings growth.
Regional House Price Forecasts
“The two most significant changes since our previous forecast have been the revival of the London market and the continued strong growth of house prices in Northern Ireland and Scotland. London house prices rose by 3.6% in the first half of 2006, the second highest rate of any English region, behind the more volatile Northern region. Both Northern Ireland and Scotland saw a significant rebound in house price growth in the first half of 2006. Northern Ireland in particular has been catching up with the rest of the UK, but with affordability deteriorating so quickly, its current rate of growth cannot be sustained going forward.
“The size of bonus payments in the City earlier this year made the headlines as a factor behind the revival of the London market but this is unlikely to be as important in future years. Rather, construction and regeneration projects (e.g. relating to the Olympics, Kings Cross, etc.), the strengthening of the London economy and shortages in the supply of housing will be more important. London is projected to have the worst supply shortages of all of the regions as workers are attracted to jobs in the capital. However poor affordability in the capital will act as a brake.
“The housing market in Northern Ireland is benefiting from the strength of its own economy and to some extent from economic and house price growth in the Republic of Ireland. However, the 14.7% rise in house prices in the first half of the year alone is unsustainable and we expect significant cooling towards more normal levels in 2007. A similar picture emerges in Scotland, where we expect some cooling of growth rates from current rates of house price growth. Even though the affordability picture is more favourable in Scotland compared to Northern Ireland, the Scottish economy is slightly less supportive.
“For most other regions we have adjusted our forecast to reflect recent house price performance and the stronger overall conditions in the UK. The regions adjoining London are likely to continue to benefit from the revival of the London market. Our forecast for East Anglia is now slightly above the UK average, due to more favourable affordability and its higher share of inward migration. Forecasts for the Outer South East and Outer Metropolitan are more modest, but the difference is small.
“The picture in the Midlands and the North is less clear. While economic conditions seem more favourable in the East rather than West Midlands, house prices have risen slightly more quickly in the West. Looking forward we expect this position to reverse and stronger fundamentals to support the East Midlands. Moving further north, house price growth has been particularly strong in the Northern region. Prices increased by 4.2% in the first half of 2006 alone, more than making up for the 3.1% fall in the second half of last year. Yorkshire & Humberside and the North West have both seen more modest growth of 2.1% over the first six months of this year. We still expect prices in these regions to grow less quickly than the UK average, but with the North West growing most slowly.
“Wales has preformed surprisingly well this year. We had expected relatively unfavourable economic conditions and deteriorating affordability to limit price growth to below the UK average. Our revised forecast now puts Wales in line with it. Performance in the South West so far this year has been similar to that in the South East. While economic conditions in the South West are favourable, affordability is a problem which moderates our view of its performance relative to the UK.”
