Market commentary

A modest improvement in the housing market

Most of the recent indicators from the housing and mortgage market continue to show signs of improvement. Turnover has risen from the exceptionally low levels seen at the start of the year and house prices are no longer falling as sharply. In fact some indices have reported monthly increases and estate agents are expecting prices to rise modestly in the coming months, the first time most of these readings have been in positive territory since mid-2007.

The recovery in housing market activity from the lows seen around the start of the year is at least partially down to seasonal factors and remains weak on any historic comparison. While it seems likely that the difficult labour market conditions, negative equity, deposit constraints for first-time buyers and restricted funding for lenders will limit how much further activity will increase, the outlook is certainly brighter than a few months ago.

A more stable economic backdrop, but unemployment set to rise further ...

The wider economy also looks to have passed the worst. The Bank of England has decided to take stock of the impact of its quantitative easing strategy, opting for the time being not to continue with the last £25 billion of asset purchases that had been authorised by the Chancellor. However the MPC itself played down the significance of this decision, with members keen to note that this did not mean that the stimulus was going to be withdrawn any time soon.

Revised first quarter economic growth estimates, to a fall of 2.4% quarter-on-quarter, marked an even more severe contraction than earlier estimates and the sharpest such drop in thirty years. As in the final quarter of last year, a large part of the contraction reflected firms cutting back on inventories severely. As there is a limit to how far stocks can be run down, this will inevitably become a more positive factor in the coming quarters. But it is not clear whether the second quarter will have seen positive or negative growth when the first estimate is published later this week, and the weak state of the household sector means that a sharp rebound is extremely unlikely. Most commentators, including the Bank of England, expect only a gradual improvement over a protracted period.

In the three months to May, the number of unemployed increased by 281,000 to 2.38 million - an unexpectedly large rise that pushed up the unemployment rate from 7.2% to 7.6%, its highest since January 1997.  The sharp increase has resurrected concerns that unemployment will eventually reach the 3 million mark. As unemployment tends to lag somewhat behind economic activity, and will probably continue to deteriorate until the economy returns to near "trend" rates of growth, this may weigh on the housing market for some time. Low interest rates will insulate households to an extent, but it is likely that we will see more borrowers struggling to make their monthly mortgage payments.

... and lending volumes remain weak as households adjust

Overall mortgage lending volumes remain low. Our estimate, that gross lending was £12.3 billion in June, was up on the previous month, but still looks weak on a seasonal basis. If there has been an increase in house purchase activity, it is likely to have been modest and, broadly speaking, offset by lower remortgaging as borrowers revert to relatively attractive standard variable rates or find it difficult to refinance due to equity constraints.

Funding conditions remain challenging, with restricted access to the wholesale markets for many firms and increased competition for retail savings. And while we might have expected lenders to see an improvement in their flow of funds as a result of borrowers fast-tracking their repayments while interest rates are historically low, there is in fact little evidence of this at the aggregate level.

Most commentators have misunderstood the reasons behind the £8.1 billion housing equity injection figure recently reported by the Bank of England for the first quarter.  We have in fact already seen four such quarters of injections, totalling about £23 billion, and more are in prospect. But this has much more to do with the ongoing difficulties facing first-time buyers wishing to enter the market and existing home-owners looking to move or borrow additional funds. It was a similar story in the early- to mid-1990s, but without the intensity created by the today's credit crunch.

Chart 1: Housing equity withdrawal and growth in mortgage balances

Source: Bank of England

Notes: Housing equity withdrawal is measured as a percentage of household disposable income on a four quarter rolling average. The mortgage balance is the year-on-year change in the outstanding balance.

As we recently highlighted in a News and Views article, the Bank's own mortgage repayment data shows that aggregate regular and lump sum principal payments have in fact not increased over recent months. The bottom line is that the household sector is de-leveraging, but this is mostly through taking on less new debt rather than repaying existing mortgages ahead of schedule.  

Looking forward, there were some further encouraging signs for lending from the Bank's second quarter Credit Conditions Survey, with firms reporting that they intend to take on a little more higher LTV lending in the third quarter. But, with little grounds for expecting the flow of money into the mortgage market to increase significantly and a weak economy and jobs outlook, we should not expect a dramatic improvement in the coming months.  Our view, echoed by other commentators in recent weeks, is that the recovery is likely to be hesitant and slow.

CML Research

1. Name: Bob Pannell
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2. Name: Paul Samter
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