Early year statistics suggest the housing market remains in soft landing mode. A recent Council of Mortgage Lenders (CML) report indicated that gross mortgage lending in January totalled £23 billion. This is the highest January total on record. The most recent mortgage approval data provided evidence that the high level of lending will be maintained during the coming weeks. Approvals in December totalled £23bn gross (which on a seasonally adjusted basis is equivalent to £29bn – source: Bank of England). The Royal Institute of Chartered Surveyors (RICS) housing market survey in January also pointed to a resilient housing market. In January, new buyer enquiries rose from plus 11 to plus 13. Expected prices fell by four points to plus 20. The Nationwide House Price Index registered an unexpected 0.2 per cent fall in February, reducing the annual rate of growth to 3.7 per cent. The key question is whether the market recovery can be sustained.
Housing demand
Housing demand reflects a number of variables, primarily personal disposable income, interest rates and consumer expectations. The strength of the housing market in January suggests that consumer sentiment remains positive. Interest rates are relatively stable at present. The path of personal disposable income is more difficult to predict. This is essentially a function of average earnings, the employment rate and the level of personal taxation. The underlying rate of average earnings growth has eased back to 3.8 per cent per annum, as companies seek to reduce labour costs in an effort to minimise the impact of higher energy prices and increased competition. We anticipate that shortages of skilled labour, in a number of sectors, will limit further downside on average earnings. However, the underlying unemployment rate at year-end was 5.1 per cent versus a mid 2005 level of 4.7 per cent. If the annual rate of UK growth rate recovers this year to 2.3 per cent, the unemployment rate should stabilise around 5 per cent.
Taxation
Planned council tax increases will increase the cost of home ownership by an average figure in excess of inflation. There is also the prospect of increases in personal taxation in Chancellor Brown’s 22 March Budget. The high level of corporation tax receipts in January has reduced the pressure on the Chancellor to increase taxation in order to meet his fiscal targets. He has also provided more room for manoeuvre in respect of the HM Treasury’s golden rule by means of extending the definition of the economic cycle to a 12-year period from 1997 to 2009. This extension suggests reluctance on the part of the Chancellor to increase the level of personal taxation beyond current plans. In recent years, overall taxation as a percentage of national income has risen from 34.8 per cent in 1996/97 to 36.2 per cent in 2004/05 (source Institute of Fiscal Studies). By 2009/10, HM Treasury forecasts that overall taxation will increase to 38.4 per cent of national income. In respect of personal taxation we estimate net increases in personal taxation are reducing personal disposable income by around 0.3 per cent per annum. We estimate that total personal disposable income will increase by just over around 3 per cent in 2006. Interest rates are forecast to be marginally lower in 2006 versus 2005. The combination of the income and the interest rate effects with the continuing shortage of housing supply in a number of areas combines to leave our house price forecast for 2006 unchanged at circa 5 per cent per annum. The risks to forecast are, however, greater than last year, due to the higher level of uncertainty over the future path of energy prices and unemployment.
Interest rates
The interest rate path is less difficult to predict in 2006. Market consensus is that base rate will remain unchanged at 4.50 per cent throughout 2006. There is unlikely to be a significant move in longer-term rates between two and five years. If there is a change in Base Rate this year, we expect it to be one 0.25 per cent reduction in the second half of 2006. We predict that the five-year swap rate (cost of mortgage lender funds) is likely to remain in a trading range close to 4.50 per cent to 4.80 per cent in the first half of 2006. The relative stability of interest rates provides a favourable backdrop for housing market this year.
Laurence Sanders is economist at Bristol & West
