Commercial insurance article archive
The outlook for interest rates and their effect on the property market
Following a year of sedate action at the Bank of England's monetary policy committee (MPC) between August 2005 and 2006 when interest rates were set at 4.5 per cent, a series of swift rises has seen the monthly MPC meeting become a hive of activity. The bank, which sets interest rates to keep the consumer price index (CPI) measure as close to its two per cent target as possible, has had to contend with increasing inflationary pressure which has acted as the driving force behind the MPC's actions. After inflation hit three per cent at the start of the year the MPC moved quickly. Adopting a series of 'pre-emptive' rises, rates have been propelled to their current level of 5.25 per cent. But what effect have these moves had on all aspects of the property market and what will the MPC's next move be?
For the average mortgage holder, one of the most important manifestations of a rising interest rate is the potential for affordability problems, with homeowners worries varying according to the specific type of mortgage in possession. Those people in possession of a variable rate mortgage, for instance, would most likely see an increase in their monthly repayments as mortgage lenders filter through an interest rate hike to their rates, with tracker mortgages similarly at risk. The Council of Mortgage Lenders (CML) recently claimed that an average variable-rate loan of £250,000 would see monthly repayments increase by over £38 – a considerable monthly hike in light of growing utilities bills and increases in council tax. In the context of a growing debt problem in the UK, with a cumulative deficit of up to £1.3 trillion, the potential for rate rises to have far-reaching and potentially catastrophic effects has been well-documented.
For homeowners the risk is obvious. Despite suggesting a number of mortgage lenders had been initially slow to amend their standard variable rates, personal finance information provider Moneyfacts predicts people whose fixed-rate mortgage period is coming to an end could soon feel the pinch. Mortgage lenders have also passed the rate rises on to their fixed-rate products - Portman, for example, has increased its two-year fixed-rate mortgage from 4.34 to 4.99 per cent.
With the impact trickling down to consumers, the CML says the potential for serious debt problems and an increase in home repossessions has grown. Anticipating a rise in repossessions to 19,000 in 2007, the group expects that figure to top 20,000 by the end of next year. Michael Coogan, director general of the CML, said that the arrears "picture" was "fairly complex" as previous rate rises took time to work through, but he did warn homeowners they may need to brace themselves for further difficulties down the line.
"Interest rates are rising again, and payment shock may be an issue for some this year as their existing fixed or discounted deals expire. Overall, we expect the total number of mortgages at least three months behind with their payments to rise from around 105,000 last year to 130,000 this year," he explained.
With three rate rises in just five months for Britons, it is likely that the impact on the property market will only be felt fully in the coming months. However, both homeowners and many analysts remain optimistic. In recent years the market has been particularly robust, with a Rics survey suggesting that last August's interest rate rise, the first for a year, failed to deflate the buoyancy of the market. Moreover, consumer confidence in the market remains high; a recent survey carried out by Yorkshire Bank showed that almost three-quarters of consumers believe house prices will continue to rise throughout the rest of 2007.
Nevertheless, the first signs that rate hikes are starting to work their way through to the market have already appeared. In its January house price index Nationwide recorded a 0.8 per cent monthly increase in property prices - the lowest for eight months. Speculating on the likely movement of rates in the coming months, Nationwide's chief economist Fionnuala Earley identified a process of stabilisation.
"It is an extremely close call between rates remaining unchanged and rising once more, but higher rates will undoubtedly add to the first signs of cooling," she commented.
Looking ahead, the general consensus has been that interest rates will be raised at least once more this year, although pundits have been caught short already in 2007, with January's rise predicted by just one analyst in the City. However, despite the widespread surprise at the timing of the MPC's decision, the upward trajectory is one most believe will continue, at least in the short-term. Like many others, Edward Menashy, spokesperson for stockbroker Charles Stanley, predicts that interest rates will peak at 5.5 per cent before returning to 4.75 per cent towards the end of the year. And the British public are also expecting further rate rises according to figures released by Lloyds TSB insurance in December last year. Then, four-fifths of Britons responding to the lender's survey said they expected interest rates to be higher in 2007 than in late 2006.
Elsewhere there is a similar picture. Like the MPC, the European Central Bank (ECB) is also acting to inhibit inflation through interest rates, as economic conditions prove encouraging and widespread growth continues in the eurozone. The ECB has raised rates six times since December 2005 and, while inflation is running at lower levels than in the UK, president Jean-Claude Trichet has vowed to remain "vigilant". Adopting a pre-emptive approach similar to that of the MPC, Mr Trichet is keen to ensure wage increases do not push up inflation. And, with the UK's current rate of 5.25 per cent well above the ECB's position at 3.5 per cent, there is plenty of room for expansion in the European base rate.
Across the Atlantic, the gap between the British rate and the US has steadily narrowed so that they are now in tandem. The Federal Reserve decided late last month to keep rates on hold at 5.25 per cent, with the economy in a reasonably strong state. However, while the Fed echoed the stance of both its European and British counterparts in pursuing an aggressive strategy to combat inflation, the situation for the property market has been markedly different. After a sustained period of rapid growth in the last ten years, prices have stumbled recently, with a large number of homes remaining unsold. In its latest announcement, however, the Fed indicated normality was returning, citing "tentative signs of stabilisation" in property sector.
For British homeowners and investors, the outlook remains upbeat. While speculation in some quarters has suggested high interest rate rises could weaken what has been a generally robust property market, commentators are speculating that it will not experience any fall-out. Bernard Clarke, director general of the Council of Mortgage Lenders (CML), noted how even after the MPC hiked rates to 5.25 per cent in January 2007, the mortgage market remained "competitive", adding that lenders continued to be able to offer "good value" to their customers. With employment relatively high and demand for new properties continuing to soar in key areas, the property market essentials look in good nick.
As Miles Shipside, commercial director at Rightmove, explained: "The reason house prices are defying the gravity of a six-year high in interest rates is because the number of new households is growing by 50,000 a year, more than the supply of new build."
As for the likely effects on the buy-to-let property market of future interest rate rises, commentators have varied in their assessment of the potential consequences. Malcolm Harrison, spokesperson for the Association of Residential Lettings Agents (Arla), said that people might struggle to meet their mortgage repayments as a result of mortgage rates being pushed up. However, although Mr Harrison said that consumer confidence was going to be knocked to a certain extent by increasing costs alongside other expenditures, he predicted that it "shouldn't have any significant effect on the buy-to-let market". Bernard Clarke, spokesperson for the CML, concurred, saying that although some decisions may be affected, as buy-to-let landlords would have to assess their costs and rents, "the market was extremely buoyant and we expect it to remain popular".
For those concerned that the bottom could fall out of the market, it is worth recollecting earlier forgotten forecasts of doom and gloom. As Michael Coogan, CML director general, put it: "The commentators who thought the housing market would crash in 2006 were wrong. Last year the market proved itself to be in robust shape and we expect it to remain so during 2007."
For the ECB, the Federal Reserve and the MPC the impetus, as always, will be to tackle inflation, but mortgage-holders across the UK will watch those rates with keen eyes and a different agenda.
16 Feb 2007