The weakening foundations of the UK housing market
Supply and demand dynamics in the UK housing market have shifted recently, with weaker consumer confidence undermining demand at a time when supply has ballooned. We expect house prices to fall in the second half of this year as growth in household income remains weak. Affordability, however, is one factor in the market’s favour, which may serve to limit price falls.
Since the General Election in May there has been a marked deterioration in UK consumer confidence. The coalition government’s determination to tighten fiscal policy by cutting public sector employment and increasing taxes, to head off a rise in bond yields, has dented consumers’ confidence in the outlook for the economy and their finances, and made them fearful of losing their jobs.
Fear of unemployment is likely to intensify over the coming months as more stories of planned public sector job cuts hit the headlines ahead of October’s Comprehensive Spending Review. But this fear may well dissipate as we progress through 2011 and it becomes clearer exactly where the axe will fall.
The deterioration in consumer sentiment has probably contributed to the fall since the start of the year in the number of properties that estate agents have sold. At the same time the number of properties on the market has risen. The increase in supply is probably the result of the recovery in prices, allowing some ‘accidental’ landlords to sell, as well as investors selling ahead of the rise in Capital Gains Tax.
The rise in the supply of properties for sale and the decline in sales have caused the all important stocks-to-sales ratio to deteriorate. This measure of the supply and demand balance continues to suggest that house prices, which have stopped rising in recent months, will fall in the second half of the year. This is a conclusion which the relatively low level of mortgage approvals supports: mortgage approvals would have to rise from their current monthly level of 48,000 to around 70,000 to be consistent with stable house prices.
The expected fall in house prices will be limited by good affordability. Low interest rates and the ten per cent decline in house prices from their peak in 2007 mean that the cost for a first-time buyer of servicing a mortgage is well below its historic average. Mortgage interest payments take up 13.4% of a first-time buyer’s income, well below the historic average of 16.1% and down from 21% when the housing market bubble was at its peak. Affordability is now as good as it was when house prices bottomed in the early 1990s.
However, while affordability continued to improve for a further two years after house prices bottomed in the last cycle, as income gains outstripped house price rises, this time around household income growth is likely to be very weak in the year ahead, as fiscal policy is tightened. With interest rates already low, any further improvement in affordability may have to come at least in part from house price falls.
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