It is fair to say that most of the UK economy is faring better than expected over the year to date, confounding the doom-laden predictions of the Bank of England and International Monetary Fund, who have both upgraded their forecasts for the performance of the UK economy over the remainder of 2023.
Whilst our economy may be performing better than expected, house price growth has come under pressure, and it is becoming increasingly evident that central bank policy is having a detrimental impact on the UK housing market. Whilst house prices have historically proved resilient in the teeth of the economic impact of Brexit and the Covid-19 pandemic, we have highlighted the likely issues that the housing market will face in the short and medium term in previous Wealth Matters, and evidence is now growing that prices may continue to fall during the remainder of the year.
Weak data all round
Nationwide’s latest house price index reading, released last week, showed that house prices fell at their fastest pace in almost 14 years in May. The survey showed that house prices contracted by -3.4% in May compared to the same period last year.
Other data announced last week underlined the headwinds facing the housing market. The number of mortgages approved for April fell to the lowest level since February, and gross mortgage lending for April was 25% lower than the six-month average. Finally, households reduced overall mortgage debt by £1.4bn in April, the highest net repayment since records began in 1993, if you exclude the pandemic period. Taking in the round, it is clear that higher interest rates are impacting on family finances, and potential borrowers are finding mortgage affordability more difficult. Of course, it isn’t just mortgage costs that have become more expensive, higher energy, fuel and food costs have a cumulative impact on already stretched household budgets.
Why the housing market matters
You may well question why house prices matter when considering the economic outlook. Whilst rampant house price inflation has implications in terms of social mobility, falling house prices over a sustained period may have a detrimental impact on the wider economic performance. When house prices begin a sustained fall, individuals are aware of a drop in the value of their main asset, and therefore feel worse off. This can see a decline in spending and a higher level of saving and raise the prospect of negative equity for those who have bought recently. In turn, higher default rates can impact on the performance of the banking sector. In addition, there are a spectrum of industries that would be directly affected by a slow housing market, such as construction, legal services, and household goods.
Why are interest rates increasing?
The Bank of England Monetary Policy Committee have increased interest rates at twelve successive meetings, raising the base rate from 0.1% to 4.5%, as the Committee use monetary policy tools to try to tame higher inflation, which spiked last year on the back of higher costs caused by the Russian invasion of Ukraine, and a hangover from the Covid pandemic. Data indicates that UK inflation is falling, however so-called Core inflation – which excludes volatile energy and food prices – remains stubbornly high. It is therefore possible that we may see at least one further increase to the base rate over coming months, as the Bank of England’s latest forecast still sees inflation above target by the end of the year.
We have been concerned for some time that central banks could push the tightening cycle too hard, and force inflation below target over the medium term. A prolonged slump in house prices would undoubtedly impact on economic growth and could increase the chance of inflation undershooting. This highlights the delicate balance the Monetary Policy Committee have to try and achieve. Indeed, two members of the Committee, Silvana Tenreyro, and Swati Dhingra, have consistently warned against raising rates too aggressively at successive meetings, and we will watch minutes of forthcoming meetings to see if more of the Committee take a dovish view.
The impact on markets
We have seen the impact of higher interest rates on global markets over the last 18 months, with Bond markets coming under significant pressure. There is potential for prolonged weakness in the housing market to play a central role in dictating interest rate policy, and bring about a more rapid fall in base interest rates as we head through the next 12-18 months. This would be welcome news to fixed interest investors, but also to Equities markets as companies should find it easier to service existing debts and fund expansion when interest rates are lower. This is particularly relevant to companies that are growing rapidly, such as those in newer industries, for example Technology.
Property as an investment
From a financial planning perspective, residential property investments can be a useful diversifier, and property investors have generally enjoyed capital appreciation together with rental income over recent years. With the likelihood that property prices will stagnate at best, or possibly see modest falls over the next twelve months, this may be a good time for those investing in property to consider the rates of return they are achieving. In addition to the financial considerations, landlords should also be considering the cost and additional work involved in meeting new regulations, and also the potential that a future government could introduce measures that have a detrimental impact on returns.
As holistic financial planners, we can undertake a comprehensive review of your assets and consider your wider objectives and requirements. Speak to one of our experienced financial planners here if you invest in property and are considering diversifying your portfolio and income stream.