05-06-2023
The economy is in a state of high inflation and rising interest rates. Newspaper headlines report house prices falling at their fastest rate for 14 years. Interest rates have gone up 12 times in a row. In this market update we ask where do interest rates go from here? What will happen to house prices? We also give our predictions, and we look ahead to the biggest deflationary event of our lifetimes.
How did we get to this point?
We have previously written about the macro environment and all of the data that brings us to the point we are at now, you can read that here.
The introduction of quantitative easing (money printing) because of the banking crisis in 2008 and then COVID has resulted in the UK government printing money to artificially stimulate the economy. Record low interest rates also helped to grow the economy and increase consumer debt over the last 15 years. A war in Europe and a prolonged lockdown in China have also contributed to increased costs due to supply chain issues. A plethora of reasons then as to why we are, where we are.
You could argue management of the economy has been poor and that anyone with some foresight could have seen that low rates and printing money would ultimately end up having to be unwound, and more could have been done sooner.
What next for interest rates and why are rates increasing?
If you are following the UK economic data, you will know that inflation remains sticky and is well above the government’s target of 2%. Whilst showing signs of slowing down, wage growth has also been increasing too with salaries rising to meet the cost-of-living crisis. To combat rising inflation and wage growth the Bank of England can increase interest rates. This is good news for savers but bad news for mortgage holders. The aim of increasing the Bank base rate is to hit consumers’ pockets which will in turn reduce spending with the intention of bringing down inflation.
Consumer price Index (CPI) data shows inflation to be falling year on year in the UK from 10.1% in March to 8.7% in April. But it’s not falling quickly enough, and core inflation (excludes energy and food) crept up and that’s worrying and needs addressing.
It’s interesting to note the different inflation data from the ONS compared to another source provided by https://truflation.com/ which suggests inflation is at 13.29%, not a pretty picture. Across the pond the US inflation is much lower with the US gov. reporting inflation at 4.9% and truflation.com stating 2.91%. The US is self-sufficient when it comes to energy though. Closer to home France reports inflation at 5.1% for April and Ireland at 7.2%.
Predictions for UK inflation this year vary:
- Bank of England – 5% for 2023 and at target of 2% late 2024
- Capital Economics 3.7% for Dec 2023
- Citigroup 3% for Dec 2023
- PWC – 3 to 4% Dec 2023
It is likely that interest rates still have a little further to go, economists and banks are predicting base rate to hit 5.25% to 5.5%. Some economists are calling for base rate to go to 6%.
Mortgage Rates
We look at swap rates to determine the cost of lending. Swap rates are the rates at which lenders borrow fixed rate money from institutions to lend to the market.
5-year swap rates are currently priced slightly cheaper than 2-year money. 5-year rates look forward 5 years and as Bank base rate starts to peak, we will start to see swap falling with 5 year money likely to remain cheaper than 2 year money.
The money markets are extremely sensitive to data and the recent inflation figures showing higher core inflation resulted in an increase to swap rates, which has filtered through to mortgage rates. Lots of lenders reprice upwards last week. Lenders such as TSB increased 5-year mortgage rates overnight by about 0.6%, this is a considerable hike. If inflation drops significantly in June, then money markets will move again and 5-year mortgage rates will be cheaper again, and vice versa.
To Fix or Float?
If you are refinancing your mortgage in the next 6 – 9 months, you have a hard choice to make as there is merit for thinking about a tracker rate which would benefit from any decreases in base rate but trying to time the market may not be best advice. If you can afford a 2,3- or 5-year fixed rate and want certainty for your household budget, then a fixed rate may be more appropriate. Each client we speak to will have their own thoughts on the market and risk tolerance and our advice will be tailored accordingly.
Incentivising 5-year Money
Another interesting factor is that some mortgage lenders will lend an applicant more money if they fix for 5 years and this is certainly true for buy to let. Sometimes the decision is made for you in a case of ‘we can lend to you but only if you fix for 5 years’. The reasoning behind this is that 5 years of fixed repayments give the applicant and the lender certainty that the loan (if affordable now) should remain affordable for the medium term of 5 years. Lending is all about risk.
Current Rates
Typical 5-year mortgage rates are currently 4.4% to 5% for main residence mortgages. Buy to Let rates vary from 4.5% to 7% with the higher rate being applicable to HMO’s and Multi unit freehold properties. Commercial rates are significantly higher starting above 7% and up to around 9%. Bridging finance rates compare quite well with rates starting at 6% and development finance is anywhere from 10.5% to 15%.
(These are approx. rates and do not refer to any particular product or lender).
Mortgage Approval Rates
Mortgage approval figures just released from the Bank of England, reported the following:
- Borrowing of mortgage debt by individuals continued to decline from net zero in March to £1.4 billion of net repayments in April. This is the lowest level on record (if the period since the onset of the Covid-19 pandemic is excluded).
- Net mortgage approvals for house purchases fell from £51,500 in March to £48,700 in April, while approvals for remortgaging increased slightly from 32,200 to 32,500 during the same period.
- The ‘effective’ interest rate – the actual interest rate paid – on newly drawn mortgages rose by 5 basis points, to 4.46% in April.
The data from the Bank of England clearly shows that the interest rate hikes are already having a large impact on the property market. With mortgage lending down this will have a knock-on effect on house prices.
How does all this affect residential property prices?
Given the current state of the economy it is likely we will see house prices fall. However, as has always been the way, certain areas will be more resilient than others. So how do the experts expect property prices to react over the next 12 months?
- Knight Frank expects prices will drop by 5% in 2023, and by the same amount in 2024.
- Capital Economics predict house prices will fall by 12% to mid-2024.
- David Miles, executive at The Office for Budget Responsibility (OBR) expects a 10% decrease. Mainly fuelled by property in Cities but offset by Rural property as people continue to want to move out of city centres.
- Rightmove are only anticipating a 2% drop this year.
- The Latest nationwide housing report expects modestly lower property prices. https://www.nationwidehousepriceindex.co.uk/reports/annual-house-price-growth-slips-back-in-may
The key driver will be how much further interest rates rise as that will curb demand. We also need to pay attention to unemployment figures.
It is worth noting that mortgage lenders have already been stress testing borrowers’ affordability at higher rates (approx..6.5% to 7%). The stress test was part of new regulations introduced in 2015 by the Bank of England.
Lessons were learned from 2008 and mortgage lending is considerably more responsible these days and that will help to reduce the impact.
The government now also have a new tool in the way of QE and as soon as that is deployed it helps to lift asset prices.
Our View
There are so many factors at play that can and will affect interest rates and house prices and making predictions is a fool’s game, however, these are our thoughts.
We expect another base rate increase when the monetary policy committee (MPC) meet on the 22nd June. There is no meeting in July and so the next possible rise will be 3rd of August when the MPC reconvene. It is our opinion that inflation will fall away very quickly, house prices will drop further but we are not looking at another 2008, we just expect a mild correction as sellers outpace buyers. We expect sellers to have to drop prices to get sales over the line and that could quite easily be as much as 10%. We continue to see high value, desirable properties continue to defy the market due to demand from high-net-worth clients.
Wages and rents are lagging indicators and yet we are already seeing a fall in payroll numbers The office for national statistics (ONS) reported a drop from March to April of 136,000, the first reduction since February 2021. We expect unemployment to increase with employers streamlining their workforce.
By the time the MPC meet in August we believe there will be enough data backing up a decision to pause. We believe the damage has already been done through 12 continuous rate hikes.
Recession
A technical recession is 2 quarters of negative GDP growth, and we don’t see that happening although it will be close. In 2024 we have an election in the UK and the current government will be doing all they can to make the economic situation better. We expect QE to start again next year if not sooner and for interest rates to start to come down again, possibly quite aggressively (by more than 0.25% at a time), giving us a base rate of around 3.5% by the end of 2024.
Our Clients
At Fox Davidson we speak daily to homeowners, landlords, businesses & property developers. All of them are feeling the pinch, naturally.
It is estimated that two thirds of mortgage holders are yet to feel the impact of the new rates. Any homeowners who have a fixed rate ending in the next 6 months will likely be refinancing at peak rates. With rates at just below 5% at best there will be quite a shock to the household budget. These clients are likely coming off sub 2% rates.
Taking advice from a mortgage broker will be essential, not only as you will need to compare the market for the best deal but also because you may need to look at other ways to bring your mortgage payments down. We are helping clients to review their payments and some consideration may be given to placing an element of your mortgage on interest only or extending the mortgage term. These considerations are not blanket advice and require careful thought and consideration as each situation is different. But if these options are the difference between retaining your home or being a forced seller then it’s worth a discussion. Note that interest only mortgages need to have a sufficient repayment vehicle at the end of the term which can include sale of the mortgaged property, subject to lender criteria and restrictions.
The sentiment in the market for landlords is low, several of which have started selling property as higher interest rates are wiping out profits from rent. Landlords have already been hit with tax changes over the recent years. Other factors influencing landlords’ decision to sell include changes to tenants’ rights and looming EPC requirements for rented property. Several developers we work with have paused any new developments due to increasing build costs and falling buyer demand.
‘Out of adversity comes opportunity’.
The smart landlords and developers we speak to are taking advantage of falling property prices and forced sellers, they are actively making lower offers on property with a longer-term outlook and a plan.
They are buying property at lower prices, perhaps extending into the loft, or adding extensions, increasing the bedrooms, and some are then renting the property as an HMO. They are adding capital value through refurbishment and development and then combatting the increase in mortgage rates by increasing the rental yield.
Some landlords are switching to renting their property out to corporations or to local authorities with tenancy agreements over 3-to-5-years. Corporate lets typically give a higher yield and better security than a 6/12-month AST.
If you are a developer building a new build site now and will be selling in 12 to 18 months’ time, then it’s reasonable to assume the worse will likely be behind us, but not a given. There is always opportunity, and we believe that landowners will finally have to start accepting that their land with or without planning isn’t worth what it was just months ago. Developers could be entering the perfect time at which to buy (it’s a buyers’ market) and could be selling into a stronger market next year. Having a plan B for retaining the property should be part of any business plan for a new development. Factoring in a 10% drop in GDV would be wise too, hence why getting the purchase price of the land/site right is imperative.
Debt
We wanted to touch on UK debt as it is not just households that have significant debt but also the UK government. Government debt is at around £2.5 trillion and increasing.
‘In the 2022-23 financial year, the government borrowed £137.1bn. That was up by about 13% from the previous year. In April, the government borrowed £25.6bn, which was the second-highest borrowing figure for April since records began in 1993.’
(Source: BBC)
Household debt sits at around £2 Trillion.
UK GDP is approx. £2.2 Trillion.
When interest rates go up it becomes more expensive for households and the government to service debt. With debt servicing increasing it means households have less funds to spend (which is the point of raising rates to combat inflation). When debt servicing is more expensive than GDP the UK Government don’t have as many funds to service their debt. We all would prefer lower interest rates and higher GDP. The battle is to get inflation down and interest rates down to a suitable level to maintain a positive GDP.
The rise of AI. The biggest deflationary event of our lifetimes?
We have already seen deflationary events take place. Post COVID many of us now work from home, that’s deflationary as we spend less on transport, we drink less overpriced coffee and spend less in town centres as we are not there 5 days a week like we used to be.
But there is another, even more deflationary event unfolding before us, the rise of AI tech and the automation of tasks. The release of chat GBT saw users go from zero to 100 million in just 2months. It took TikTok 9 months to reach that goal and Instagram 2.5 years. When you consider that Businesses are already starting to use AI, automation of tasks by AI will increase exponentially, all of which is hugely deflationary.
The UK is pushing to be AI friendly and will be hoping to attract tech startups. We could very well be facing the most deflationary event of our lifetimes. PWC estimate that GDP will increase substantially due to AI alone. How quickly all of this happens we just don’t know but it is has already started and the technology is moving very fast, we believe the technological advances in AI over the coming months and years will surprise us all.
Some useful resources on the deflationary and GDP effects of AI.
UK Gov whitepaper on AI – https://www.gov.uk/government/publications/ai-regulation-a-pro-innovation-approach/white-paper
PWC report into AI from 2018 – The macroeconomic impact of artificial intelligence (pwc.co.uk)
Fox Davidson provide advice to clients wishing to fund residential and commercial property in the UK. We work with everyone from first time buyers to property developers and businesses. To discuss your mortgage requirements with one of our experienced consultants please do get in touch.
Sources:
Truflation:
Europe inflation rates:
https://tradingeconomics.com/country-list/inflation-rate?continent=europe
Unemployment rate: https://www.ons.gov.uk/employmentandlabourmarket/peopleinwork/employmentandemployeetypes/bulletins/uklabourmarket/latest#main-points
Government debt:
https://www.bbc.co.uk/news/business-50504151
Mortgage approvals:
https://www.bankofengland.co.uk/statistics/money-and-credit/2023/april-2023
UK Data: United Kingdom Forecast (tradingeconomics.com)
Bank Rate history and data | Bank of England – Last 20 years
Date Changed Rate
