Housing market pick-up benefits whole economy - UKCIG

A key feature of the downturn has been the slowdown in housing market activity in those economies that had previously seen a boom in residential construction, house prices and the associated increase in mortgage debt held by the household sector. Indeed, it was the increase in mortgage debt and the securitisation of that debt that was at the very epicentre of the financial crisis once it became apparent that the marginal quality of the debt was deteriorating rapidly

House prices began falling in the spring (US) and summer (UK) of 2007 and only in the past few months has there been any indication of prices finding a bottom. The number of housing transactions also fell rapidly. In the US, sales of new single family homes peaked at an annual rate of 1.4 million in July 2005 and then fell steadily until the recent low of just 332,000 in March 2009. By March 2009 the number of UK property transactions had dropped to a third of their end-2006 peak.

The weakness of the housing market and its associated impact on residential investment spending has been a significant drag on economic growth. According to official statistics, UK house building starts were a mere 40,000 in the first half of 2009 compared to 66,000 in the first half of 2008, 84,000 in the first half of 2007 and 93,000 in the first half of the boom year of 2006. In the US, the GDP data show a 15-quarter consecutive decline in residential investment spending at an average annual rate of 20%. This type of spending has fallen from over 6% of GDP to under 3% in the space of three years, taking well over 1% off GDP growth per year during that time.

So where do we stand in the housing market now? The most recent evidence has been quite encouraging. In the UK the main house price indices have shown monthly price increases for the past six months. The Halifax house price index now stands just 1.5% below its previous year level while the Nationwide index is actually 1.9% higher than in October 2008. Data from the monthly RICS survey of the housing market has also been more positive.

The house price balance reached 34.2 in October and both the sales/stocks and the new buying enquiries/new instructions ratios point to further gains in prices in the months ahead. Furthermore, despite genuine concerns about the lack of credit growth in the wider economy, mortgage lending has been rising steadily. Mortgage approvals reached 56,215 in September. This is still a long way from the average level of the previous 15 years but the improvement in lending is welcome.

Falling repayments

More than anywhere, UKCIG homeowners have benefited from low interest rates. Although by long-term historical standards, housing remains expensive, it has become much more affordable over the past two years as a result of falling borrowing costs and prices. Those borrowers on variable rate mortgages – and it is estimated that roughly half the outstanding mortgage stock is on variable rates – have seen monthly interest payments tumble. In aggregate, interest payments from the household sector have fallen from 9% of household income in 2007 to less than 1% today. The Council of Mortgage Lenders has revised down its estimate of the number of mortgages expected to be in arrears in 2009 to 195,000 compared to a previous estimate of over 300,000. It cites low rates and the willingness of lenders to be more flexible with borrowers facing financial difficulties.


Impact on the economy

I think housing could now start to make a considerable contribution to the recovery in the US and UK. The recent level of home building has fallen below the required long-term average supply of new housing. This is seen in the US data. The ratio of houses for sale to houses sold (representing the number of months of 'spare' supply of housing at prevailing sales rates) has dropped from a peak of over 12 months in January to 7.5 months now. If sales continue to rise as they have in recent months the pace of home building will have to pick up.

While demographic studies in the US suggest that the rate of household formation has and will continue to slow, the current low rate of housing starts is not sustainable. In the Q3 GDP data for the US, residential investment spending rose at an annual rate of 23.3%. Of course, part of the fiscal stimulus is geared to reviving the housing market but the likelihood is that this source of aggregate demand for US can make a sizeable contribution to growth, say of 0.5% per year.

In the UK, the rate of household formation is expected to remain strong. According to the government the growth in the number of households in England is to average around 220,000 per year until 2026. Last year, official estimates put the number of dwellings completed in England at just 157,000. A 60,000-70,000 shortfall in the availability of new supply will mean more building and higher house prices.

A revival in housing has all kinds of positive implications for the broader economy. Consumer confidence will be boosted by the stabilisation and modest increase in house prices. Consumer spending will be boosted by any pick up in the number of housing transactions as spending on furniture and fittings will pick up. Employment will be created if residential investment spending recovers and this will provide a further boost to spending.

Inflation

A revival in housing will also be watched with interest by the Bank of England. During the boom in house prices the MPC consistently argued that there was no clear link between house prices and consumer spending and was reluctant to tighten monetary policy just because house prices were rising rapidly when the official inflation numbers were subdued. Of course the problem wasn’t house price inflation per se but the credit boom that fuelled price increases. Nevertheless, if there is a sustained pick up in housing activity and house prices in 2010 this will be another factor contributing to a rise in official interest rates.

The bond market reacted in a fairly sanguine way to the release of the November Inflation Report despite the upward revision to both GDP and CPI forecasts. The message from the MPC – at least in the press conference – was that the recovery would be fragile and that after a spike in inflation in early 2010, the spare capacity in the economy would force inflation lower again in 2011. The message was that the Bank of England will keep rates low for as long as it takes to be sure that that banking system is back on a sound footing.

Outlook

It will be fascinating to watch the evolution of the Bank’s message in 2010. The reality is that the data keeps on improving. The unemployment rate remained at 7.8% in September and the increase in the number of people unemployed was considerably less than expected (the smallest monthly increase since April 2008). The British Retail Consortium’s latest retail sales monitor was also upbeat showing a 3.8% increase in like-for-like sales to the year in October and a 5.9% total sales growth rate.

We know that there is fiscal tightening coming and that there remains the risk that the global recovery runs out of steam, but on the basis of what the data is showing us today – strong manufacturing, a resilient consumer and an embryonic recovery in the housing market, together with a sharp increase in the major inflation measures – the Bank of England will need all its renowned powers of intellect and persuasion to convince a trigger-happy bond market that it can keep rates at 0.5%. I am starting to believe that the major risk is earlier monetary tightening than is currently priced in.

In a couple of weeks the gilt market will see the introduction of new two-year and five-year bond futures contracts. With two-year gilt yields at 1.28% and given the above arguments, I would bet there will be quite a bit of short-interest in the two-year future.

UKCIG Property News, November 2009