• UK economic growth forecast 2 per cent in 2008; 2.8 per cent in 2009
• Base rate expected to fall to 5 per cent within the next 3 months
• Net mortgage lending remains resilient
• Annual rate of house price inflation continuing to fall towards zero.
The UK economy is slowing in response to the impact of last year’s Base Rate increases and the reduction in world trade as a consequence of the credit crunch and the rise in commodity prices.
The International Monetary Fund recently revised down its forecast of 2008 world growth to 4.1 per cent, although this is still above long-term trend.
We predict that UK growth will slow to 2 per cent per annum this year before returning to trend (2.8 per cent) in 2009.
Economic data in the first half of the year is likely to be negative, including a gradual rise in the annual inflation rate. The increased cost of energy and food prices is more than balancing the reduction in many high-street prices in response to the slower rate of growth of consumer demand.
We expect target inflation – CPI – to peak in the Summer, very close to the top of the government’s 1-3 per cent target inflation range.
There is no pressure on wage costs. Underlying average earnings have remained in a 3.4 per cent to 3.9 per cent range since late 2005.
The unemployment rate has also remained in a narrow range since the end of 2005. This stability in the labour market is an important factor in our view that the housing market downturn will be short-lived.
Countervailing pressures
The latest Bank of England Quarterly Inflation Report highlighted the countervailing pressures facing the Monetary Policy Committee (MPC), primarily the upturn in global inflation and the impact of the international credit crunch on western economy personal and business sector phsychology.
The Inflation Report predicted that there is a high probability that CPI will rise to the top of the target range later this year, against a background of a slowdown in UK growth.
Given the long time lag involved in monetary policy, the MPC focus will be on the longer term economic outlook.
Based on the Bank of England’s inflation projections, we perceive that there is clear scope for one further reduction in Base Rate to 5 per cent. If the UK economic slowdown was to gather momentum, we are confident that the MPC would reduce Base Rate to 4.75 per cent.
Global inflationary pressures are likely to remain a factor in determining UK retail price levels. We therefore anticipate that next year, Base Rate will return to 5.75 per cent. The trough in period rates is likely to occur in the Spring. Thereafter, we expect to see a gradual increase in period rates.
A gradual downward trend
There was a surprising increase in December’s seasonally adjusted net lending, to £8.6 billion. We expect to see a gradual downward trend in net advances during the first half of 2008, and predict that seasonally adjusted net advances will fall to £6 billion in May, after which the cumulative impact of Base Rate reductions should lead to an upturn in mortgage business.
Gross mortgage activity should also be boosted in mid-year by the large volume of maturing fixed rate loans and a perception that period rates are close to a 2008 low.
One area where there has been a significant reduction in business is the non-conforming mortgage lending area. The more generous lending terms offered by certain larger lenders have also been scaled back.
However, there should be no reduction in credit availability to mainstream borrowers. We continue to predict that net lending will reach a trough of £6 billion in the Spring, although we have scaled back our Q4 forecast to £9 billion per month.
A stabilising market
The annual rate of house price inflation is steadily falling towards zero. This year we expect the housing market to stabilise in late Spring, in response to a fall in Base Rate to 5 per cent or 4.75 per cent. Our house price forecast for 2008 is zero. If average house prices do fall into negative territory, this would be beneficial from a first-time buyer viewpoint.
The latest Council of Mortgage Lenders data shows that the average house price to average income ratio has reached a level that we perceive as the maximum sustainable ratio in the current interest rate environment. Any further increase in average house prices is dependent on increases in personal disposable income.
We expect average earnings to remain in the 4 per cent per annum region. The expected rise in personal taxation should be balanced by growth in the working population. We therefore expect average house price inflation to be 4 per cent next year.
