The UK economic outlook has deteriorated. This reflects the scale of the international credit crunch. Recently the International Monetary Fund (IMF) downgraded its forecast for world growth in 2009 from 3.0% to 2.2%. The IMF forecasts that the UK, US and Euro zone economies will remain in recession until mid 2009. The slowdown in world growth is especially negative from a UK standpoint, given that foreign trade is equivalent to 25% of gross domestic product (GDP). The domestic economy is also in downturn mode in response to the impact of the credit crunch on residential and business lending. The UK authorities have responded with a significant monetary policy boost and with fiscal policy expansion. The Chancellor, in his Pre-Budget statement on November 24th, announced a package of VAT tax reductions and increased government investment, a mini Budget that was designed to boost business and consumer confidence. Due to the time lag in the impact of interest rate reductions on the UK economy, the latest economic forecast in November’s Bank of England Quarterly Inflation Report is that the UK faces a ‘V’ shaped downturn and recovery, with a significant fall in output during first half 2009, followed by a significant recovery in the latter part of the year. We concur with the view that the UK economy will gather momentum in the Summer of 2009, and predict that the economy will return to trend growth (circa 2.5% per annum) in 2010. There is a general consensus that the Winter months will be a very difficult period for the UK economy as unemployment rises towards 7%.
From a housing market viewpoint, the most positive development during the past month has been the acceleration in interest rate reductions. The 1.5% reduction in base rate on November 6th was, in MPC terms, unprecedented. Moreover, the Bank of England Quarterly Inflation Report, published one week later, paved the way for further falls in base rate. Money markets currently discount a reduction in base rate to 2%. It is quite conceivable that the MPC will reduce base rate to 2% at the December 4th meeting. A reduction of at least half a per cent is highly probable given that the tone of the November MPC Minutes. The outlook for both inflation and growth has changed significantly in recent weeks. UK target inflation (CPI) peaked at 5.2% per annum in September. It has since fallen to 4.5% and the Bank of England predicts that CPI will fall below the 2% target in Winter 2009/2010. A key factor has been the sharp decline in commodity prices, notably crude oil, whose price has more than halved since mid year. The combination of weaker economic growth and lower inflation has also led to a significant reduction in long term interest rates. The international economy is the key driver of long term rates and the benchmark US federal funds rate has fallen to 1.0% with the prospect of a further reduction before year end.
In normal times, a substantial reduction in base rate would have led to a strong upturn in the mortgage market. These are exceptional times. Despite the substantial injections of liquidity by the world’s leading central banks, the international credit crunch remains a barrier to economic growth worldwide. At the heart of the problem is US non prime mortgage debt, which has been securitised and sold worldwide. The scale of non performing sub prime debt is thought to be well in excess of $2,000 billion. The exposure of individual institutions has yet to be fully quantified, hence the uncertainty in international financial markets, which has led to a wide gap between base rate and financial institution cost of funds. Until very recently, the gap between 3 month sterling LIBOR and base rate was well over 1%. This is a clear indicator of the pressure on mortgage lenders in respect of cost and availability of funds. The problem is global and confidence in international money markets is likely to return at a very slow pace. Vigorous central bank action has at least stemmed the tide. Net mortgage lending has stabilised just above zero. Gross approvals have stabilised at around £14 billion per month (the average figure for the four months July to October inclusive). Over the Winter months we expect gross approvals to remain in the region of £14 -£15 billion per month, steadily recovering in the Spring and Summer months as impact of the credit crunch very gradually eases.
The key barrier to housing market recovery is the supply of credit. This factor is strongly correlated with the scale of the international credit crunch. Concerted central bank action has turned the tide, but the scale of the recovery of confidence in international financial markets is painfully slow. In addition, the consequent economic downturn is exerting a strong negative impact on the UK unemployment rate, with negative consequences for housing demand. The annual rate of house price inflation has fallen to minus 14% and is likely to reach a trough of minus 20% in the Winter months. Thereafter the gradual improvement in mortgage credit should stabilise house prices. We anticipate that the monthly rate of house change will slow from the current of minus 1.5% to around zero in the Spring of 2009. The monthly rate of house price change is expected to accelerate in the second half of the year, with house price inflation gathering further momentum in 2010 in response to the expected upturn in the economy.
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