The Bank of England repo rate was left unchanged at 4.50 per cent in April, with the last change being in August last year. Financial markets are less positive on the outlook for rates, pricing in a rise to 4.75 per cent by the middle of next year. Two, three and five-year rates have also firmed. Our view is that rates will remain unchanged for the next few months at least with house purchase activity stabilising following the upward trend seen over the past year. Affordability pressures remain intense. New household projection figures underline the mis-match between housing demand and supply and mean that house prices are likely to remain well supported.
Economic background
Oil prices have started to rise again and gas prices look set to rise further. This is likely to result in inflation rising above the 2 per cent target and constrain household spending growth over the coming months. It also raises questions over whether inflationary expectations will remain well-anchored or whether wage pressures will start to respond to the squeeze on incomes. Indeed, real household disposable income was flat in the fourth quarter of last year. Close-to-trend real spending growth was financed by a reduction in saving and increases in mortgage equity withdrawal.
Elsewhere, the stronger picture that was emerging just a month or two ago is now looking more mixed. Industrial production fell in February, although the trend remains one of modest improvement and order books are rising. The new National Statistics index of services output was flat in January. But underlying growth in the services sector remains above the long-run trend and survey information to March suggests this continued. Backward-looking labour market indicators point to a modest softening, but forward-looking indicators, such as vacancies, are more positive.
Overall the data appears to be compatible with the economy growing close to the trend rate, although it is not clear that growth will strengthen appreciably over the next couple of quarters. Indeed, the National Institute of Economic and Social Research estimates that the economy, as a whole, grew by 0.6 per cent in the three months to March – in-line with the trend rate, but down a touch on growth of 0.7 per cent in the three months to February 2006.
Housing market developments
The strength of house price growth evident in most house price measures in recent months continued into March. Activity was unseasonally strong in the normally quiet Winter months. There are some indications that underlying activity may be stabilising, but there is some ambiguity in the housing market.
The Halifax reports a 0.9 per cent increase in house prices in March and a 1.6 per cent increase in the first quarter. Nationwide reports a 1.1 per cent increase in the month and a 2.5 per cent increase in the first quarter. The annual rate of increase has now risen to 5-6 per cent from lows of around 2 per cent last Summer. Over the past year, annual house price inflation has slowed in all regions with the exception of Greater London, where house prices are being supported by a lack of new supply and strong City bonuses.
Surveyors and estate agents continue to report strong buyer interest, although this might now be levelling out. Completed sales are well up on levels of the past year, but have stabilised over the past month. The stock of available property for sale is falling. The average time to sell a property is declining, but remains higher than 18 months ago. Sale prices being achieved, as a per cent of the asking prices are rising. Buy-to-let interest remains strong.
HMRC property transactions are a timely measure of activity, but they include some commercial transactions and so do not relate to the housing market alone. The underlying level appears to have been essentially flat since September. This is broadly in line with the figures for the number of loans approved for house purchase
Household projections
The Office of the Deputy Prime Minister (ODPM) has released new household projection figures for England. These show an average increase of 209,000 a year over the period 2003-2026, from 20.9 million to 25.7 million. The annual increase is projected to be higher over the next five years, at 216,000, and rise to 228,000 a year between 2011 and 2016.
One-person households account for over 70 per cent of the growth, of which 60 per cent are individuals aged 55 and above. About 60 per cent of the growth will be in the southern regions – London, the South East, East and South West – although they account for only a little over 50 per cent of all households. The figures confirm that household growth in England since 2001 has exceeded the level of housing completions by more than 50,000 a year. This will have been an important factor driving the rise in house prices and the decline in housing affordability in recent years.
The latest projections compare with 189,000 a year published in 2004 and 153,000 a year published in 1999. And they compare with an annual level of housing completions in England in recent years of 150-160,000 (135-145,000 private sector completions). House building will have to be sustained at a much higher level over the next 20 years, and towards the top end of the additional 70-120,000 a year range suggested in the Barker Review, if the government’s objective of an improvement in housing affordability in the market sector is to be achieved.
Mortgage market developments
The underlying number of mortgage approvals has been essentially flat since September, at a seasonally adjusted 300,000 a month. The figure for February was a little lower, at 295,000. The value of loans approved has stabilised at a historically high level of £28-29 billion a month.
The number of loans approved for house purchase fell to 115,000 in February from 121,000 in December and January. The number of approvals for remortgaging has stabilised, but is lower than in the autumn. We expect the level of remortgaging activity to pick up again over the next few months, and there may already be some evidence of this. Seasonally adjusted gross mortgage lending fell by 1 per cent in February to £27.4 billion. This was 26 per cent higher than a year earlier. February is typically the weakest month of the year for mortgage lending. Early indications are that gross lending rose very sharply in March and that, in seasonally adjusted terms, it will have exceeded December’s record level by a substantial margin. Seasonally adjusted net lending fell by 9 per cent in February to £8.1 billion. This was the weakest month since October. Underlying growth in mortgage lending outstanding remains above 11 per cent. The number of approvals for other loans – mainly further advances – fell in February, ending the modest strengthening since last Summer.
According to the Bank of England, mortgage equity withdrawal increased to £11.8 billion in the fourth quarter of 2005, equivalent to 5.6 per cent of post-tax household income. This is a significant pick up from the average of £8.2 billion a quarter, 4 per cent of post-tax household income, in the previous four quarters.
Outlook
House purchase activity will stabilise following the upward trend seen over the past year. Affordability pressures remain intense for first-time buyers and the attractiveness of moving will be adversely affected by high transactions costs, notably stamp duty, the rising costs of home ownership in the form of council tax and bills and the prospect of only modest house price growth.
For some time, we have been looking for remortgaging activity to strengthen from the spring, as large numbers of fixed-rate deals are set to mature. This may be on the verge of showing through in the approvals and advances figures. Our forecast of a moderation in house price growth towards 2 per cent is based on less buoyant house purchase activity. But the new ODPM household projection figures underline the extent of the mismatch between housing demand and housing supply. Until this structural imbalance is adequately addressed, the pressure will be for real house prices to rise.
Financial markets have become less positive on the outlook for interest rates over the past month. They are now pricing in a rise in the Bank of England repo rate to 4.75 per cent by the middle of next year. Two, three and five-year rates have also firmed a little. This may dampen enthusiasm for remortgaging and fixed-term borrowing. Rates seem unlikely to fall unless economic activity turns out to be substantially weaker than expected.
Jim Cunningham is senior economist at the CML
