• UK growth rate rises to 3% per annum
• Base rate may well peak at 6%
• Impact of rising interest rates primarily on net advances
• First signs of slowdown in annual rate of house price inflation
Recent key data
(percentage figures are year on year)
UK consumer price index (CPI) June 2.4%
UK underlying average earnings May 3.5%
UK unemployment rate (underlying – ILO) May 5.4%
UK economic growth 1Q 07 3.0%
UK gross mortgage lending May £30.1bn
(secured on dwellings, seasonally adjusted)
UK net mortgage lending May £8.7bn
(secured on dwellings, seasonally adjusted)
Nationwide house price index June 11.1%
Halifax house price index June 10.7%
Brent oil price (1mth forward) mid July $76 / barrel
Bristol & West Predictions
Base Rate 2yr fixed rates 5yr fixed rates
(semi annual) (semi annual)
Current Rate 5.50 6.35 6.25
End 2007* 6.00 6.10 6.05
End 2008* 5.50 5.60 5.60
* forecast amended in response to MPC monetary policy stance and the upturn in the global economy.
UK growth rate rises to 3% per annum
UK economic growth remains robust. The National Statistics Office has revised up its estimate of Q1 growth to 3 per cent per annum. The key driver remains the service sector, which continues to expand at a rate of around 4 per cent per annum. The most recent data indicates that the momentum of UK growth will be maintained.
The July reports of the Chartered Institute of Purchasing and Supply (CIPS) presented an upbeat picture of the UK economy. The key CIPS service sector index showed the overall index rising by 0.5 to 57.7. This level is compatible with sustained service sector growth in the region of 4 per cent per annum. The outlook for business activity in both goods and services is sustained by the high level of world growth and by the recovery in the economies of continental Europe, the UK’s largest export market. There is no undue cost pressure in the labour market and underlying average earnings continues to be in a range circa 3.50-3.75 per cent. Nevertheless, there are inflationary pressures, which reflect the strength of the world economy and the consequent increase in prices of internationally traded consumer goods and commodities. The strongest impact is the increase in oil prices, which will feed through into many sectors of the UK economy.
A 6 per cent peak?
Despite the lack of inflationary pressure in the labour market, the Monetary Policy Committee raised the Base Rate on 5 July to 5.75 per cent. In the accompanying press statement, the Bank of England referred to upside risks to inflation, including the rising level of commodity prices, a function of the sustained high rate of world growth. The global economy has been expanding at a rate of circa 5 per cent per annum for the past three years and this looks set to continue for the remainder of the decade.
Until recently, the prices of many UK consumer goods have been on a downward trend, reflecting the availability of very low cost imports. The growth in Asian consumer demand for consumer goods is now starting to place upward pressure on the prices of many UK imported products. There is a distinct probability that Base Rate will be increased to 6 per cent within the next three months. We may well be entering an era when an average Base Rate of 5.50 per cent is the norm. The international economy is a key driver of longer term rates. Given the probability that both the eurozone and US economies will be in recovery phase in the second half of 2007, we believe there is moderate upside potential in period rates. The two-year swap rate could peak in the region of 6.50 per cent during the Autumn before easing back to current levels in Q4.
To date, the impact of interest rate reductions has been felt largely on net mortgage activity. Gross advances have remained in excess of £30 billion in response to the very significant volume of re-financing. A large number of borrowers are coming to the end of their two and three-year fixed rate deals and are seeking lower cost solutions to the challenges posed by the recent increases in both period and standard variable rates.
The impact of higher interest rates has been felt primarily in the first-time buyer market, although this factor must be placed into perspective. First-time buyers still represent over 35 per cent of completions by number of loans for house purchase. One of the most buoyant aspects of the mortgage market is buy-to-let. There are commentators who believe this market is close to a peak regardless of the substantial imbalance between housing supply and demand. One argument is that the growth in incomes is not sufficient to support further increases in rental growth. We do not concur with this view. Housing is a prime need, and one consequence of the rise in property prices is that many people are spending a higher percentage of their income on housing. In addition, one of the most rapidly growing sectors of the housing market is the significant increase in the number of people in higher education. This sector is partially supported by parental financial assistance. We therefore expect the momentum of the buy-to-let market to be sustained.
First signs of a gradual slowdown
During the past three months, the increase in the Halifax House Price Index has slowed from 0.8 per cent per month to 0.4 per cent per month. However, the annual rate remains in excess of 10 per cent per annum due to the high rate of house price inflation in the second half of 2006. We expect the annual rate of house price inflation to ease back to 6 per cent by Q4 2007 and to 5 per cent per annum in 2008. The Halifax data is consistent with reported comments from one of the largest house builders indicating that there has been a downturn in demand for their most recently completed properties.
The market appears to have reached the point where there is distinct customer resistance to higher house prices. We expect the downturn in the annual rate of house inflation to be gradual.
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