Residential Property Focus

Residential Property Focus
 
The market's change of gear

3 November 2016, by Chris Buckle

Economic uncertainty post Brexit will put a brake on house price growth, despite lower interest rates

 

A year ago when we announced our five-year forecasts, we were anticipating that a stable economic backdrop would provide a period of relatively strong price growth whilst interest rates remained low.

Brexit has forced the market to change gear and created uncertainty. Against this new backdrop, our forecasts are for slower growth.

Although we are expecting economic growth to remain positive, households will face weaker income growth and there may be some job losses over the next two years. The period of negotiation with the EU is likely to be a rollercoaster of confidence, with volatile sentiment indicators and lower levels of business investment.

As importantly, the amount buyers are borrowing relative to their incomes is already stretched in some parts of the market. In particular, it is bumping up against the limits of mortgage regulation in London.

While falling mortgage interest rates will create some capacity for house price growth over the next two years, buyers are unlikely to want to stretch their finances much further in uncertain times.

So it is difficult to see any significant potential for house price growth until the terms of the withdrawal from the EU are agreed and economic growth picks up.

FIGURE 1

Regional diversity: Five-year forecasts in context

 
Five-year forecasts in context

Source: Savills Research using HM Land Registry and Registers of Scotland

Back to normal?

Brexit negotiations are expected to be concluded by early 2019, bringing to an end the two-year period of greatest uncertainty. As buyer confidence returns, low mortgage rates should mean there is capacity for a small bounce-back in house prices.

It is anticipated that economic growth will return to trend from 2020, but this is likely to coincide with some gradual upward pressure on interest rates. Brightening economic prospects should lift consumer sentiment, but increasing interest rates will work as a brake on potential house price growth in this period.

Regional differences

The effect of Brexit is complicating a natural shift towards the later stages of the housing market cycle, when the strongest growth is seen beyond London and the South East.

All regions are expected to see reduced house price growth as the economy slows. But as interest rates start to rise, this is likely to be most acute in London.

Here competition for housing, fuelled by low levels of housebuilding, has increasingly led buyers to stretch their borrowing levels. The average buyer borrows four times their income in the capital, though their ability to do so has been dependent on low interest rates.

The tightening of affordability is likely to be most significant in those parts of inner London that have seen the highest house price growth and still rely on the availability of mortgage debt. In comparison, outer boroughs of London are likely to perform more in line with markets in the commuter zone.

The impact of higher mortgage rates is likely to be much less acute in the more affordable markets of the Midlands, Wales and the North of England. These areas have more capacity for house price growth, but most lack the economic catalyst needed to unlock this potential. Economically active markets such as Manchester are expected to outperform their regions.

Scotland is likely to continue to see price growth in line with the North of England, with the strongest growing markets focused in the central belt. Aberdeen, which showed the strongest post credit crunch growth, will continue to be a drag on the national numbers as long as oil prices remain low.

FIGURE 2

Mainstream drivers and house price forecasts

 
Mainstream drivers and house price forecasts

Source: Savills Research, Oxford Economics


Other economic scenarios to consider

Our forecasts are based on Article 50 being triggered in the first quarter of 2017. They also assume negotiations with the EU are broadly positive, but result in limited additional access to the single market beyond standard World Trade Organisation rules.

But rarely, if ever, has economic forecasting been less certain. The myriad of possible Brexit outcomes means there are numerous divergent scenarios for the economy, which have the potential to affect the outlook for house prices.

Growth comes earlier If consumer confidence holds up through 2017 and job losses are muted, house price growth could occur earlier in the forecasting period. This would leave markets more susceptible to an affordability squeeze when interest rates rise.

Fiscal stimulus Increased public sector investment would support employment and deliver stronger economic growth. This would boost consumer confidence, incomes and, in all likelihood, house prices. However, rising interest rates would reduce affordability to put a cap on it.

Low growth The current resilience of the UK economy may be short-lived, with a greater negative economic impact becoming clear over the course of the negotiation. This may lead to a further weakening of the pound, higher inflation and rising interest rates, which would reduce the capacity for house price growth.

 

 
House price growth is forecast to slow in the mainstream market

▲ House price growth is forecast to slow in the mainstream market

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