Prospects for UK housing Market

 

Inflation and Interest rate Prospects

The UK housing market has seen remarkable increases in average house prices since the last slump in 1992. The prospects for the future however are much more uncertain.

Firstly, it depends upon the future direction of interest rates. The Bank of England has increased interest rates 3 times in the past couple of months. This is in response to rising inflation. CPI inflation has now reached 3% with a rise in Core inflation. Using the old RPI inflation index inflation is even higher (close to 4%). If inflation continues to rise it could lead to further rises in interest rates. However the governor of the Bank of England recently stated he expected inflation to fall in the second half of the year.

If interest rates rise in the UK it would have a serious impact. Many homebuyers are already stretched. Further increases in the cost of mortgages would likely to create a significant fall in demand and prices could start tumbling. The high number of mortgage holders holding a variable mortgage exacerbates the impact of rising interest rates. This means any change in the base rate will effect their monthly mortgage payments immediately. If more homeowners had a fixed rate mortgage the housing market would be less sensitive to interest changes.

Importance of Real Interest Rates

On the other hand; other economists point to the fact that, although nominal interest rates have increased, real interest rates are relatively low. Nominal interest rate is the current rate of interest (5.25% Jan 2007). The real rate of interest is the nominal rate – inflation rate (5.25%- 3%) = 2.25% This is actually quite low by historical standards. If you were to use the more inclusive RPI measure of inflation the difference would be even less. The effect of this is that borrowing is still relatively steep. This explains why the recent rise in interest rates has had little effect on slowing down the housing market. Therefore even if interest rates were to rise moderately it is quite possible demand would still be robust and therefore there will be no fall in house prices.

realinterest rates

Furthermore another method of calculating the real effective interest rate is to include in the equation capital growth. If you include capital growth of house prices it makes borrowing to buy a house even more attractive.

The buy to Let Market.

The Buy to Let Market plays an increasingly important role in the British Housing market. This is because people buying with the intention of renting take a significant share of the buyers market. Usually this group of buyers are hoping and expecting to make capital gains. Therefore if prices did start to fall then they could be panicked into selling to preserve their capital gains. This could magnify any swings in the housing market and turn a modest fall into a significant slump. This is the worst-case scenario for the British housing market, but it is still a possibility. Remember what happened in Japan.

Prospects for UK Supply of Housing

The UK government is committed to building new houses, however in reality the number of new homes being built is at an all time low. In the short term there is little prospect of a significant increase in supply of housing. This shortage of available housing has been a major factor in keeping house prices high.

UK Mortgage Market

Mortgage Market. In the past decade or so the mortgage market has seen an increase in the number and variety of mortgages on offer. The general trend has been to offer bigger mortgages than previously was the norm. For example in the past income multiples of 3 to 1 were the industry standard. However many lending institutions are increasingly lending mortgages up to 6 or 7 times the disposable income of a borrower. The effect of this is to support the rise in house prices to earnings ratio. With more people getting big mortgages it enables them to afford the high prices. This has been one reason for maintaining high house prices in the UK. It means the prospects for future house prices may involve continued high prices.

 

Article By R.Pettinger 4/02/2007