UK economic growth remains just above long-term trend at 2.7 per cent per annum. The most positive development of the month, from a mortgage perspective was that the target inflation rate was unchanged at 2.4 per cent per annum. The Consumer Price Index (CPI) had been expected to rise to 2.8 per cent per annum as a consequence of the rise in university tuition fees. The impact of the rise was less than anticipated and this factor was balanced by a significant fall in petrol and diesel prices. It is now highly probable that CPI will peak below the top of the government’s 1-3 per cent target.
Recent economic data has, on balance, been neutral from a housing market viewpoint. While underlying average earnings eased back to 3.5 per cent per annum, the volatile average earnings, including bonus figure, once again rose above 4 per cent per annum. It is the latter which is the principal driving force of the housing market. The impact of the rise in earnings was balanced by the rise in underlying unemployment to 5.6 per cent. This gradual rise, if sustained, represents a significant risk to the market. Our view is that the authorities will take the necessary monetary policy action in the second half of 2007 before unemployment reaches a level that would make a notable impact on consumer confidence
Base Rate peak
The Bank of England raised Base Rate (BBR) to 5 per cent on 9 November, in line with expectations. We continue to predict that this will represent the BBR peak. In its recent Quarterly Inflation Report, the Bank made reference to the lack of inflationary pressures in the labour market and to the recent reduction in energy prices. The economic projections in the report do not suggest any undue inflationary pressures in the UK economy. The Bank’s projections are based on the financial market view that BBR will peak at 5.25 per cent. Given that the most recent UK inflation statistics were somewhat lower than expected, we continue to hold the view that a 5 per cent peak should be sufficient.
Longer-term rates are determined by a combination of domestic and international factors. There has been a marginal reduction in two-year plus rates over the past month, in response to the slowdown in the US market. We expect longer-term rates at year end to be close to current levels. Our forecast is dependent on the Chancellor adhering to his fiscal rules in the 6 December pre-Budget statement.
Mortgage lending
Statistics suggest that gross mortgage activity is running at around £30 billion per month. The most recent data reflects house purchase decisions made some time ago. Empirical evidence indicates that there has been a slight downturn in mainstream mortgage business as a result of the August BBR increase. A marginally more significant downturn is expected in the light of the most recent BBR rise. The high level of house prices indicates that there is likely to be further growth in buy-to-let. This is like to be driven by potential house buyers who are unable to make the first step on the property ladder. Other areas of specialised lending are also expected to grow, including impaired credit and remortgage activity from borrowers seeking to consolidate their debt.
There is no evidence of a significant increase in arrears. The recent well publicised increase in personal debt is largely confined to personal credit as opposed to mortgage activity. Our 2007 forecasts remain unchanged at £110 billion net and £360 billion gross.
Imbalance
The rise in the Halifax Index to 8.7 per cent is an unwelcome sign. Few in the market wish to see a return to housing market boom/bust. The increase in BBR to 5 per cent should cool the market and bring the rate of inflation back to long-term trend of about 5 per cent per annum. If house price growth remains in the region of 8-9 per cent, the Bank would probably raise BBR to 5.25 per cent.
The level of house prices reflects the forces of supply and demand. The number of participants in the UK labour market continues to increase despite the gradual rise in unemployment. There is a shortage of housing in many parts of the UK. At present, there is no sign of an increase in housebuilding to a level that would bring average prices down to the rate of consumer price inflation. Given the current level of excess demand in the housing market, we have marginally revised up our 2007 house price forecast by 1 per cent to 5 per cent per annum.
