The latest BOE survey of credit conditions indicated that mortgage lenders were planning to reduce the supply of home loans at the fastest rate since the early months of the pandemic in 2020. At the time, lenders were withdrawing good many of their most attractive offers as soon as it became clear this lockdown would last considerably longer than originally anticipated. This drove average mortgage rates higher even as the BOE cut its base rate, first from 0.75% to 0.25% and then to a record high of 0.1% in March 2020.
Some lenders then went further. Barclays Plc suddenly cut its maximum loan to income ratio from 5.5 times to 4.49 times. The new policy applied even to mortgages that had been “agreed in principle”. Many real estate deals collapsed, with buyers unable to finalize their purchases, often losing money already spent on studies and legal fees. As it happens, thanks to the holiday, mortgage default rates have remained low and confidence has quickly returned to the market.
Now, however, lenders are getting cautious again and this time there is no furlough scheme to protect consumers squeezed by the cost of living crisis. UK inflation accelerated to 7% in March and is set to rise further after the regulatory cap on household energy bills recently jumped by 54%.
Banks seem to take into account the risk of recession. This is not only apparent in the projected supply of home loans. Mortgage rates also signal trouble ahead. It’s rare for five-year fixed mortgage rates to fall below the two-year average rates, but when they do, it can create problems. It happened in the late 1990s and in 2008, and it’s happening again now.
In 1997, a financial crisis gripped much of East Asia. The following year, Russia defaulted and the hedge fund Long-Term Capital Management collapsed. Fearing for the stability of the financial system, policymakers cut rates. But after the long economic contraction of the early 1990s, UK house prices were still more than 30% below their 1989 peak in real terms. In no case was the market considered too large and therefore suffered little damage.
In 2008, however, the situation was very different. The global financial crisis was characterized by reckless lending on both sides of the Atlantic. House price inflation spent most of 2007 in the double digits. The national housing price index increased by almost 160% in real terms between 1998 and 2007 to reach an all-time high.
Luckily, it looks like the current housing situation in the UK looks more like it was in 1997 than it did in 2008. Taking inflation into account, house prices are still 8% below 2007 peak.
Lenders are much more cautious. Strict affordability guidelines for borrowers have been in place for several years. Retail banks compete on price, not on relaxing their credit controls. In 2014 the BOE banned mortgage lenders from extending more than 15% of their new residential mortgages to loan-to-income ratios of 4.5 or more – the rule that caused Barclays to withdraw in 2020.
The housing market is also less immediately sensitive to the cost of mortgages. The English Housing Survey shows that homeowners who have never had a mortgage, or who have paid it off, outnumber those who have had mortgages for nearly a decade. Some 74% of residential mortgages have fixed interest rates, rising to 96% for new borrowers since 2019, according to trade body UK Finance.
So while banks have every reason to be concerned about the economic outlook, their current borrowers are less concerned. An economic downturn should see fewer forced sellers of property. Expect the UK property market to see a marked slowdown in activity, but not a substantial drop in prices.
The issue that no one has addressed, however, is that the housing market has become more secure precisely because it now excludes so many of those looking to start out in life but who do not have the income to do it. Instead of the “landlord democracy” ideal of former Prime Minister Margaret Thatcher, housing in the UK is simply becoming an increasingly exclusive club of those who don’t need mortgages and those who are sufficiently solvent to be mortgaged.
Therein lies the real unsustainability of British property. The market can dodge a crash, but it is still in a state of crisis.
This column does not necessarily reflect the opinion of the Editorial Board or of Bloomberg LP and its owners.
Stuart Trow is an investment strategist, most recently at the European Bank for Reconstruction and Development. He is a financial coach, co-host of “Money, Money, Money” on Switch Radio and author of “The Bluffer’s Guide to Economics”.
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