September Economics Update. Economic and housing market. Bradford Property Forum. Created by:

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1 September 2014 Economics Update Economic and housing market Bradford Property Forum Created by:

2 Bank Rate timing of first increase Q or Q1 2015? The debate over the timing of the first increase to Bank Rate appears to have narrowed to mainly two options; Q (likely November) or Q (likely February) with those months coinciding with the Bank s Quarterly Inflation Report publications. Of 43 forecasts to Bloomberg, 12 economists expect Bank Rate to have increased to 0.75% by the end of A total of 37 expected Bank Rate to have increased to at least 0.75% by the end of the first quarter of LIBOR pricing suggests the first rate hike will occur in the first quarter of 2014, SONIA pricing suggests the second quarter of

3 Evidence for a Q4 move Why move early? Proponents of an earlier move to increase interest rates believe that, in theory, it will allow the Bank of England to stick to already its stated aim of slow and gradual rises in Bank Rate by reducing the ability for inflationary pressures to build. The labour market has been far stronger than the Bank expected a year ago when announcing its forward guidance. Using the unemployment rate as a measure of slack in the economy would suggest that spare capacity has been used up quickly and the level of spare capacity remaining has diminished substantially. Given the time lags in the transmission mechanism of monetary policy, it would therefore be more prudent to move to increase rates soon. Moving to increase rates will also send a signal to consumers that they need to prepare their household finances for an increase in borrowing costs. 3

4 Evidence for a Q1 move (or later?) Why wait? There are still a number of reasons to suggest that the Bank of England can delay any increase into the first quarter of 2015 and perhaps even later. The MPC has focused specifically on wage growth in recent statements as an indicator that sufficient slack still remains in the economy. Data for June 2014 showed wages growing at an annual rate of just 0.6%, well below the rate of inflation which stood at 1.9% in the same month. Despite stating that the Bank would not be afraid to act on interest rates before wage growth showed up in official data, a majority of the MPC indicated that they were comfortable to wait for further evidence of a pickup in wages. Not only do wages have implications for measuring the degree of slack in the economy, below inflation wage growth indicates that household finances will still be getting squeezed. Increasing interest rates, and therefore the cost of servicing debt repayments, could push highly indebted household over the edge. Concerns remain that British households are still too highly leveraged. External risks also remain significant. From an economic point of view, weakness in Europe continues and will likely weigh on UK economic activity for some time to come. Geopolitical risk also carries the potential to destabilise financial markets and entering a rate hiking cycle at this point carries risk. The UK general election in May does not factor into the decision to hike rates or not in our opinion. The Bank of England has strongly asserted its independence and would be unlikely to make a decision based on its potential impact on the political cycle. 4

5 Bank Rate new normal rate What is the new normal or neutral rate? Earlier this year MPC members began to suggest that the new normal for Bank Rate (at least in the medium term) was likely to be substantially below the 5% average witnessed before the financial crisis. Initially this was suggested to be 3%, more recent comments from Mark Carney have lowered this even further to a range of 2.5-3%. The theory behind the new normal rate settling lower than the historical average depends on the outlook for lending spreads. Lenders have maintained wide spreads between the policy rate and actual lending rates as they rebalance balance sheets and have to cover the cost of holding greater amounts of capital and liquidity. These requirements are unlikely to ease and there is therefore an assumption that spreads will remain at current levels; a lower policy rate than pre-crisis will result in a similar lending rate. Market pricing is also broadly in line with these suggestions. LIBOR pricing suggests a rate at the end of 2019 of 2.75%, SONIA of 2.25%, while implied forward rates show a two year swap at 2.75% and a five year swap at 3% - it is however hard to imagine a five year swap rate having no spread over Bank Rate, suggesting that swap rates will likely be higher than current market pricing suggests. 5

6 Housing market - headlines Prices House prices have continued their year on year gains and there is little evidence to date that this pace is slowing, despite RICS surveys suggesting this would be the case. As at the end of July, prices were up by around 10-11% compared with 12 months earlier, depending on which measure is used. Increases have primarily been driven by London and the South East with London up by around 19% over the past year in contrast to the North East that has seen an annual price change of just 2%. Activity Land Registry transactional data released to date only covers the first five months of In that period, almost 340,000 transactions were recorded an increase of over 30% on the first five months of Recent RICS surveys point towards a slowing of demand in the market (and even a fall in July) compared with an increase in the number of new properties coming to market. Surveyors are therefore less optimistic on the prospect for increased sales volumes than they were at the end of 2013 although still expect an upward trend. 6

7 Housing market London and the South East Analysis in the regional breakdowns is based on Land Registry data to allow for consistency between the price and transaction data. House prices in London and the South East have seen the strongest annual increase of all regions, up by 19% and 10% respectively. Sales volumes in London have however been on a downward trend which appears to be more than just a seasonal pattern. Volumes have been falling consistently since the start of 2014 while other regions have seen a general upward trend. Taking evidence from RICS surveys, this is likely to be a result of falling demand rather than a lack of available property. 7

8 Housing market rest of the UK The housing market across the rest of the UK has not experienced price growth as rapid as that witnessed in London. As the following page shows, average property prices in London have now surpassed their post recession low point by more than 50% and are also more than 30% above their pre-recession peak. All other regions are now above their post recession low points ranging from an increase of 4.5% in Yorkshire and Humberside to 26.7% in the South East. However, only London (30.8%) and the South East have surpassed their pre-recession peaks. The rest of the UK range from -0.1% in the East of England to -21.7% in the North East. Clearly London, and to some extent the South East, have a far stronger housing market than the rest of the UK. Evidence from the RICS surveys suggest that this position may change soon as surveyors in London become less optimistic about the outlook for prices over the rest of the year. Transactions have increased across all regions when comparing the first five months of 2014 with the same period last year. Increases in sales volume range from 23.6% in London to 34.1% in the East Midlands. 8

9 Housing market the rest of the UK 9

10 Mortgage market residential Prime residential Gross lending in the first seven months of 2014 totaled 117bn a 27% increase on the same period in Over the same seven month period net lending in 2014 reached 14bn, a substantial 270% increase on With macroprudential tools (discussed in more detail later) looking to target specific measures such as LTI, the following page includes graphs showing lending for house purchase broken down by a number of measures. Lending at or above 90% LTV has increased to c.20% of lending from a post-recession low of 9% as lenders re-enter riskier markets. Although this is still below the pre-recession high of 34% when loans over 95% LTV accounted for around 8% of the market. Similarly lending at higher LTIs has increased as prices have increased whilst wage growth has remained stagnant. Lending in the 4-5x income multiple category has reached a record high of around 22% of lending, well above its pre-recession peak of c.16%. Mortgage terms have also been increasing in length. The proportion of mortgages for house purchase taken out for a term of greater than 30 years has reached a record high of 20%. The Help to Buy schemes continue to support the market with the equity loan scheme having recorded 29,000 completions and the mortgage guarantee 18,500 as at the end of June. The schemes have arguably helped exactly the purchasers the government set out to target. The average price of a property purchased was 188,000 despite the 600,000 limit. Only 6% of purchases have taken place in London and a further 15% in the South East. Additionally, 82% of users of the scheme have been first time buyers. 10

11 Mortgage market residential 11

12 Mortgage market buy to let Buy to let lending continues to recover on both a value and volume measures. Data shows that in the second quarter of ,000 BTL mortgages were advanced at a value of 6.3bn. This was an increase of 22% in volume terms from a year earlier and 31% in value. This remains some distance below the peak achieved in the second quarter of 2007 when 93,000 BTL mortgages were advanced at a value of 12.7bn. Arrears and possessions on BTL mortgages also continue to improve with both measures now at postrecession lows. Arrears rates on BTL properties are currently around half the rate of owner-occupied properties. 12

13 Mortgage market macroprudential policy Further policy on the horizon? The BoE implemented its first attempts at macroprudential policy by capping lenders to 15% of their new lending at loan-to-income ratios of 4.5 or greater and directing that an appropriate interest rate stress in assessing affordability would be an increase in Bank Rate of 3pp during the first five years of a loan. It is too early to tell whether this will have a fundamental impact on the mortgage market. The directive has not yet been enforced but the FPC expected it to be around 12 months before lending at an LTI of 4.5x would start to reach the cap. Some lenders such as LBG pre-empted this move by introducing their own LTI caps but stated that these would affect a relatively small proportion of their businesses. Recent headlines have focused on the increase in the proportion of mortgage being taken over a longer term than the traditional 25 years. As extending the term of a mortgage is another way to increase the amount one can borrow, and exposes the borrower to greater sensitivity to interest rate changes, the Bank of England could look to introduce a measure similar to the LTI cap. As previously seen, the proportion of mortgages for house purchase with a term over 30 years has now reached 20% for the first time. 13

14 Summary Key assumptions Pace of economic growth to increase this year before moderating again in Business investment to pick up and replace consumer spending as a source of growth. Productivity to improve as a result of investment decisions. Labour market improvement to continue but at a slower pace than experienced in the last 12 months due to productivity gains, self-employment, part time employment etc. Inflation to remain close to target and household expectations for future inflation to remain grounded. Earnings growth from 2014 onwards to exceed inflation although some of this benefit in future years to be eroded by increasing debt repayments. Interest rates to begin to increase early in 2015 ending the year at 1% but only reaching just over 2% by House price inflation to slow this year and settle at around 5% per annum for remainder of forecast. Risks Sterling strength and deflation from Europe keep rates lower for longer. Scottish independence causing political and financial market turmoil. Overzealous regulation from FPC/PRA in light of housing bubble risks. Interest rates increased too early and/or too quickly causing arrears/defaults to increase. 14

15 appendices Created by:

16 economic scenario Variable Bank Rate (%) GDP (%) CPI Inflation (%) ILO Unemployment (%) Average Earnings (%) House Price Inflation (%) Gross lending ( bn) Net lending ( bn)